Some 88 per cent of UK investment trusts are currently trading on discounts wider than their one-year average, according to the latest FE Trustnet study, with uncertainty surrounding today’s EU referendum almost certainly a major driving force behind the trend. 
A recent FE Trustnet study showed that open-ended global funds have their lowest weighting to UK equities in three years, with the potential ramifications of today’s vote causing many fund managers to steer clear of FTSE-listed stocks.
Certainly, the barrage of news flow relating to the referendum has already had significant implications for UK assets as sterling has weakened, equities has fallen and bond prices have increased due to the fact that it seems a dead heat between a Leave or a Remain victory.
The latest FE Trustnet poll reflects this nervousness, as 58 per cent of readers are currently waiting for greater clarity in regard to the UK’s future relationship with the EU before they put their money to work.
As such, it is no surprise that demand for shares in closed-ended UK funds has fallen – but the extent of which is eye-opening.
According to data from the AIC, 87.71 per cent of trusts across the IT UK Equity Income, IT UK All Companies and IT UK Smaller Companies sectors are currently trading on a wider discount to NAV than their 12-month average.
Given the amount of volatility investors have had to deal with since June 2013, it is also telling that 62.96 per cent of trusts in the space are trading on wider discounts than their three-year average.
This discount widening has had a big impact on investors’ total returns so far this year.
Though NAV returns have been hard to generate in 2016 so far due to poor investor sentiment, FE data shows the average trust in three UK equity sectors has lost 4.23 per cent year to date thanks to discount volatility compared to combined a 1.6 per cent loss from the open-ended IA UK All Companies, IA UK Equity Income and IA UK Smaller Companies sectors.
Performance of UK funds and trusts versus index
Source: FE Analytics
Currently, the average discount across the three UK sectors is 6.97 per cent – which compares to a 4.72 per cent average discount over the past 12 months.
Looking at it slightly differently, the average UK trust is currently trading on a discount that is 8.98 percentage points wider than its lowest discount over the last year but just 3.87 percentage points lower than its widest discount over that time.
Understandably, it has been the UK trusts focused on smaller companies that have felt the brunt of the poor sentiment.
Following a good 2015 for the market area due to improving UK economic fundamentals and the Tory victory at the general election, concerns about the impact a Brexit would have on smaller companies have meant both the FTSE Small Cap and FTSE 250 index are underperforming the FTSE 100 so far this year (though the latter has only really been saved by a significant rebound in bombed out mining, oil and bank stocks).
The average discount in the IT UK Smaller Companies sector is now 11.07 per cent and, as the table below shows, the likes of Montanaro UK Smaller Companies, JP Morgan Smaller Companies and Henderson Smaller Companies are some of the hardest hit.
UK small-cap trusts on the widest discounts
Source: The AIC
Certain trusts have gone against the trend, however, with Invesco Perpetual UK Smaller Companies and the Rights & Issues Investment Trust currently trading on narrower discounts than their one-year average.
It’s a different story in the IT UK All Companies sector, though.
All but one of the 15 members of the peer group are trading on a wider discount than their one-year average, include Fidelity Special Values, Keystone and Woodford Patient Capital. The sector is now trading on a 7.85 per cent discount to NAV, compared to an average discount of 5.26 per cent over the past 12 months.
Aurora Investment Trust is the only member of the peer group to have bucked this trend, following a change in management. The serial underperformer is now run by Phoenix Asset Management, which has a successful track record in the UK equity market via offshore domiciled funds.
Since Phoenix took charge of the portfolio in January 2016, its discount has narrowed considerably to just 0.92 per cent.
Aurora Investment Trust’s discount history over 5yrs
Source: FE Analytics
Though IT UK All Companies and IT UK Smaller Companies trusts have largely been hit by widened discounts as demand for their shares has fallen, the opposite is seemingly true in the IT UK Equity Income sector.
Indeed, the sector is trading on a 2.03 per cent discount to NAV, which is some 30 basis points narrower than the peer group’s one-year average.
However, this is almost entirely down to the performance of one of its members. Data from the AIC shows that 19 of the 26 trusts in the sector are trading on wider than average discounts, it’s just that the tiny British & American Investment Trust has rocketed to a 75.4 per cent premium to NAV compared to an average premium of 40 per cent over the past 12 months.
Once that trust has been removed, the average discount in the sector is 5.12 per cent compared to an average of 4.03 since June 2013.
That being said, Mark Barnett’s Edinburgh Investment Trust, Job Curtis’ City of London Investment Trust and the Small Companies Dividend trust managed by Chelverton have seen their discounts narrow as well.
Our recent poll suggests that investors are waiting for the result of the referendum to invest, though the consensual view is that if the Remain camp wins, UK equities will witness a relief rally given the amount of capital sitting on the side lines.
Analysts at Winterflood agree with this and say there are a number of trusts that would make the most of a more positive market environment.
“In the event that the UK votes to remain in the EU, we would expect a relief rally, which arguably has already started, in predominantly UK-focused businesses. As such, we would not be surprised to see a strong short-term fillip to mid and small-cap companies,” Winterflood said.
“We believe that investment trusts are a good way of playing any such rally due to the impact of gearing and, more importantly, the possibility that discounts might narrow as a result of renewed buying interest.”
“Our favoured names in this space remain The Mercantile Investment Trust and Henderson Smaller Companies. Both offer some value on discounts of 13 per cent and 14 per cent respectively to their NAV. Mercantile has the advantage of greater liquidity with a market cap of £1.6bn, although Henderson Smaller Companies also offers good liquidity in the secondary market and has a market cap of £452m.”
Winterflood say investors should consider value-orientated trusts in the case of as Bremain – in particular Fidelity Special Values and Alastair Mundy’s Temple Bar, both of which have seen their discounts widen recently and have posted losses over the past 12 months.
Performance of trusts versus index over 1yr
Source: FE Analytics
“We do not believe that a bounce would be confined purely to UK mid and small-caps and our favoured more mainstream UK names include Temple Bar (7 per cent discount) and Fidelity Special Values (3 per cent discount).”