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How bargain hunters have doubled their investment trust returns – and more

16 June 2015

Narrowing discounts have been one of the biggest drivers of equity trusts since the financial crisis, but experts warn that investors shouldn’t expect as many re-ratings in the years to come.

By Joshua Ausden,

Head of FE Trustnet Content

Picking investment trusts prior to a significant narrowing of their discount has added up to 150 percentage points of return to net asset value (NAV) performance over the past three years, according to FE Trustnet research.

A number of academic studies have proven the benefits of scoping out cheap, oversold areas of the market. Using this approach when selecting investment trusts can give investors a double whammy effect, as they profit not only from rebounding share prices but narrowing discounts as well.

The best illustration of this in recent years is 3i Group – the third best performing investment trust in total return terms since June 2012. Our data shows the team behind the £5.3bn vehicle have grown the NAV by a modest 44.74 per cent over the period; however, due to a massive swing in the discount, the share price has risen by 198.73 per cent.

 

Source: FE Analytics

If investors had reinvested their income, this figure would have jumped to 238.03 per cent.

FE data shows the trust was on a discount of around 30 per cent this time three years ago, but has since then jumped to a 36 per cent premium. It was as high as a 44 per cent premium earlier this year.

Numis Securities investment trust analyst Euan Lovett-Turner said: “The key problem with 3i Group was its balance sheet. During the credit crisis it had issues with the amount of debt it had taken on, and as a result it had a very difficult time.”

Discount/premium of trust since June 2010

 

Source: FE Analytics

“[Chief executive] Simon Borrows has come in and done a very good job at getting the balance sheet into decent shape and communicating this message to shareholders. It has reduced its gearing and is returning a cash dividend out of realised gains, which has also proved popular.”

Lovett-Turner points out that the ownership base of the private equity trust is far broader than the average closed-ended company and tends to be viewed as a financial. This can lead to bigger swings in sentiment, he adds, though 3i has been on at least a double-digit premium for some time now.

While 3i Group is an extreme circumstance, a number of trusts have been buoyed by changes in the discount/premium.

Lindsell Train IT – a global trust run by star manager Nick Train – has returned an impressive 221.68 per cent from an NAV point of view over the past decade. This puts it well ahead of the MSCI AC World index, which has returned 73.53 per cent.


 

Train’s NAV return looks somewhat modest compared to the experience of investors however; FE data shows the trust has returned 322.98 per cent in share price terms, and over 400 per cent in total return terms.

 

Source: FE Analytics

Lindsell Train IT was on a 6 per cent discount back in June 2010 but at time of writing sits on a 22 per cent premium.

Even over the short term, narrowing discounts and rallying premiums can lead to a significant boost in performance. Neil Woodford’s Woodford Patient Capital Trust, which raised £800m at launch, has managed just over 3 per cent in NAV terms since it was launched last month. Investors in the trust have seen their capital rise by more than 11 per cent however.

Performance of trust since launch

 

Source: FE Analytics

The trust was oversubscribed even though its capacity at launch was extended. The trust first had a fundraising target of £200m with leeway to raise up to £500m – the limit was eventually lifted to £800m.

Woodford Patient Capital came to market on a 4 per cent premium, which has risen to around 10 per cent at time of writing thanks to yet more demand for shares.

Lovett-Turner says the narrowing of discounts across the board in light of high demand for risk assets means there is less obvious value for bargain hunters on a medium to long-term view.

He highlights a number of IT Private Equity trusts as having the potential for a significant re-rating, though unsurprisingly doesn’t include 3i Group in this group.

“When you look at 3i there’s definitely better value elsewhere in the private equity space. Most of the sector is trading on discounts in the mid-teens,” he said.

“I think there’s quite a few opportunities for strong NAV performance and a re-rating of the discount. Discounts have been coming in over the past couple of years but I could see this continuing.”

The analyst highlights HG Capital, which is on a discount of 10 per cent, as well as SVG Capital and Pantheon International Participations, which trade on 15.2 and 18.8 per cent discounts respectively.  Pantheon’s discount was as high as 45 per cent in September 2011 and its share price has more than doubled since then.

Lovett-Turner says there’s always the potential to find one-off bargain stories, highlighting Standard Life UK Smaller Companies and JP Morgan Mid Cap as ones to watch in the coming years.

The first of these traded on a premium to the rest of the IT UK Smaller Companies sector following stellar performance in the 2000s, but a recent soft-patch has seen it fall onto a 10 per cent discount. This illustrates the risks of buying trusts after they’ve had a significant re-rating, he says.


 

“You’ve always got to be wary when a trust is on a significant premium. If performance is unexciting, sometimes the premium can come away quite quickly,” he said.

“Harry Nimmo has an excellent track record but his style has been out of favour for a while. In the past it’s often proven to be a good time to pick up his trust.”

“JP Morgan Mid Cap is another one, which is on a 13 per cent discount. It had a change in manager three years ago, and Georgina Brittain has done a really good job beating her benchmark and peer group significantly.”

Performance of trust and benchmark over 3yrs

 

Source: FE Analytics

FE data shows the trust’s share price has risen by 130.83 per cent over the past three years, compared to 75.24 from the mid-cap index.

While finding discount opportunities has been key to maximising returns from investment trusts in a number of cases, Lovett-Turner insists it’s by no means the be-all and end-all.

“Fundamentally you’ve got to identify a good manager and the right asset class, and the discount should be seen as a bonus,” he said.

Discount volatility can work against you if buy the wrong trust just as dramatically as if you pick the right one.

The poor performance of natural resources trusts in recent years has been compounded by mass selling, leading the likes of City Natural Resources High Yield to fall from a 4 per cent discount in March 2014 to a 24 per cent discount at time of writing.

The trust’s NAV is down just under 16 per cent over the last 12 months, but the share price is down 27 per cent. 

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.