In some instances, changes in the discount or premium can have an adverse effect on performance.
If an asset class goes out of favour and investor demand falters, a widening discount amplifies the poor performance of a trust.
It can also present investors with a problem when it comes to buying.
The best-performing closed-ended vehicles are often on steep premiums, which Numis’ Charles Cade says can be dangerous if demand suddenly falters.
"If the premium closes, this has an impact on performance," he said.
Many of the trusts in the IT UK Growth & Income sector are currently on premiums, and unsurprisingly, it is the strongest performers that lead the way.
Expensive UK equity income trusts
| Name | Premium (%) |
|---|---|
| British & American IT | 5.4 |
| JP Morgan Income & Growth IT | 5.1 |
| Edinburgh Investment Trust | 2.7 |
| City of London IT | 1.6 |
| Temple Bar IT | 1.5 |
Source: The AIC
Among those on the steepest premiums are Alastair Mundy’s Temple Bar IT, which has delivered more than 100 per cent over five years; Neil Woodford’s Edinburgh Investment Trust, which tops the sector since the star manager took over back in September 2008; and Jonathan Woolf’s British & American IT, which is yielding a whopping 9.14 per cent.
While buying trusts such as these could be seen as a risk, there are other options in the sector with greater scope for upside gains.
Here are three dividend-paying UK trusts currently on a significant discount to net asset value (NAV).
Invesco Income Growth IT
Former FE Alpha Manager Ciaran Mallon is part of Woodford’s highly rated equity team at Invesco Perpetual, but does not get the same kind of coverage as the star man.
His Invesco Income Growth IT is on a discount of 6.9 per cent, according to the AIC, making it one of the cheapest trusts in the sector.
Mallon has performed well since taking over the £174m trust in January 2005, although has been outdone by Woodford in recent years.
The trust has beaten its FTSE All Share benchmark over one, three and five years, albeit with slightly more volatility.
Performance of trust vs index over 5yrs
Source: FE Analytics
Like Woodford, Mallon has a bias towards large cap, defensive companies.
Healthcare and tobacco have a hefty weighting in the portfolio – AstraZeneca, GlaxoSmithKline, Imperial Tobacco and British American Tobacco are all top-10 holdings.
However, the trust is far less concentrated than Woodford’s, with the top-10 only accounting for 33 per cent of assets. By contrast, the Edinburgh IT’s top-10 accounts for over 60 per cent.
The smaller size of the trust gives Mallon the flexibility to take positions in smaller companies in the FTSE 100, and even mid cap companies which have superior growth potential.
According to the AIC, FTSE 250 companies have a 19 per cent weighting in the trust, while those in the FTSE Small Cap index have a 6 per cent weighting.
Although the Invesco Income Growth IT focuses more on growth companies than the Edinburgh IT, it currently has a slightly higher yield – 3.8 per cent compared with 3.7 per cent.
Cade says the trust is attractively valued, but points out that the draw of Woodford and FE Alpha Manager Mark Barnett – who heads up the Perpetual Income & Growth trust – means that it is unlikely to see a huge uptick in demand anytime soon.
"It's more mainstream than Edinburgh and takes fewer big sector bets," said Cade.
"There is potential for the discount to come in, but because it's smaller and isn't run by Woodford, it's difficult to make a case for buying it when Edinburgh is on offer."
Invesco Income Growth has an ongoing charges figure (OCF) of 0.99 per cent and is 9 per cent geared.
JP Morgan Claverhouse IT
Sarah Emly and William Meadon’s trust is currently on a discount of 9.8 per cent, according to the AIC.
JPM Claverhouse is currently yielding 3.6 per cent and is one of the cheapest trusts in the sector from a charges point of view, with an OCF of 0.75 per cent.
It has one of the strongest records for income in the entire sector, boasting 40 consecutive years of dividend growth.
It has beaten its FTSE All Share benchmark over one, three and 10 years, but a very poor period between 2007 and 2008 means that it has fallen short over five.
Performance of trust vs index over 5yrs
Source: FE Analytics
Emly has run the trust since June 2006; Meadon joined her last year.
The pair invest predominantly in large caps, but are less reliant on defensives than their Invesco rivals.
Banks, and oil and gas are both sector overweights – the likes of Rio Tinto, HSBC, Barclays and Prudential are all top-10 holdings.
Cade thinks this is a very good option for bargain hunters, and recently tipped it as an attractive value play to clients.
"This is a bit of a turnaround story – performance was pretty poor but has improved of late," he said. "It always takes a bit of time to recognise the improvement, so it's still good value."
Cade points out that the trust has recently moved IT UK Growth sector to the IT UK Growth & Income sector, and has also changed its style.
"It used to draw on behavioural finance methods, but is now more driven by fundamentals, and is higher conviction in its approach," he added.
The £382m trust is 17 per cent geared.
Value & Income IT
This trust is on the biggest discount by some distance – in excess of 20 per cent, according to the AIC.
Angela Lascelles and Matthew Oakeshott have run the trust since 1986, making them the longest-serving duo in the entire closed-ended universe.
They have led the trust to outperformance compared with the FTSE All Share over one, three, five and 10 years.
It is yielding 3.7 per cent at present.
Cade says the trust is the standout value play in the sector, but points out that it is not comparable to other UK equity income trusts.
"It’s very illiquid – not only because of its size, but because it has a big stake in property. This tends to put people off and so it isn’t really fair to compare it to other trusts in the sector."
According to the AIC, property has a 30 per cent weighting at present.
"It’s got a decent yield, has performed pretty well and is on a steep discount, so it’s definitely a solid yield play. Oakeshott’s property portfolio is strong, and they’ve also done well on the core equity side."
"It doesn’t trade that actively, which also puts people off. This is a problem for institutional clients, but it shouldn’t really be a problem for retail investors."
The £175m trust has an OCF of 1.32 per cent, excluding performance fee. It is 25 per cent geared.
Lascelles also heads up the five crown-rated CF Olim UK Equity fund.