They say the best-performing trusts in the Japan, European and technology sectors – all of which have had an outstanding year – are looking too expensive and recommend cheaper alternatives.
Investors should also consider switching out of the UK small cap sector and into emerging markets, they suggest.
Baillie Gifford Shin Nippon has produced the second-best share price performance and NAV returns of any Japan-focused investment trust over the past 12 months, a break-out year for the market.
The trust has returned 66.08 per cent to investors over the year, while the managers have generated NAV returns of 52.4 per cent. The MSCI Japan Small Cap index has returned just 28.26 per cent.
Performance of trust vs sector and benchmark over 1yr
Source: FE Analytics
"Japanese markets performed strongly following the more aggressive growth policies from the government and central banks, commonly termed Abenomics," said Ewan Lovett-Turner, analyst at Numis.
"Smaller companies have kept pace with the broader market despite a domestic focus at a time when exporters have been boosted by a 15 per cent depreciation of the yen against the US dollar year-to-date."
"The manager, John MacDougall, focuses on growth companies operating in expanding niche markets."
"Many of the best-performing stocks were online businesses, notably Start Today (3 per cent of assets), a clothing website; Digital Garage (3.2 per cent), which provides advertising strategies and payment solutions to small internet companies; and F@N Communications, a facilitator for online marketing."
Lovett-Turner says that while he rates MacDougall highly, the current premium of 6 per cent is too much, especially considering the sharp re-rating it has seen in the past year.
"Baillie Gifford Shin Nippon tends to perform strongly in positive markets and has significantly outperformed its peers over the past 12 months," he said.
"However, the fund [£112m market cap] is currently trading on a 6 per cent premium, which compares with a 15 per cent discount a year ago and discounts ranging from 7 to 14 per cent for the peer group."
The analyst recommends switching into the £80m JPM Japan Smaller Companies, which is trading on a 9.8 per cent discount, or its sister fund, the £390m JPM Japanese, which is on a discount of 9.2 per cent.
JPM Japan Smaller Companies is the more direct peer, focusing on the lower end of the market cap scale. It has made 44 per cent in share price terms and 36.6 per cent in NAV terms over the past year.
JPM Japanese, on the other hand, is a large cap fund that has done very well out of the weakening yen, returning 57.3 per cent in share price terms and 43.9 per cent in NAV terms.
Performance of trusts vs indices over 1yr
Source: FE Analytics
"JPM Japanese was a dull performer for many years, but this has been turned around by the current manager, Nicholas Weindling, through a focus on quality companies in secular growth markets (not dissimilar from Baillie Gifford’s approach)," Lovett-Turner commented.
The fund has ongoing charges of 0.76 per cent, according to the AIC, much lower than its large cap rivals. JPM Japan Smaller Companies is more expensive at 1.57 per cent.
Oriel Securities' Tom Tuite Dalton says it may be wise to switch European trusts as well.
"As Alex Darwall noted in Jupiter European Opportunities’ interim results, it has been a low-quality rally with the most highly leveraged and least seaworthy boats rising most," he said.
"As a result, Europe is now being recommended by a wide range of financial advisers, having been shunned by many prior to the market recovery, and discounts have narrowed across the board."
"The contrarian investor may now be tempted to lock in profits or to switch allocation to a pure stockpicker like Jupiter European Opportunities, which aims to hold companies that are not vulnerable to falling European demand."
Tuite Dalton also notes that small cap European trusts have not seen the re-rating of their large cap counterparts, potentially making them more interesting for investors who like to play narrowing discounts.
"It is noteworthy that of the European funds, TR European Growth, up 42 per cent year to date, which has a focus on small and mid caps, has witnessed the strongest return and seen its discount narrow to 13 per cent from over 20 per cent."
"Yet it remains cheap relative to more large cap focused funds, including sister trust Henderson Euro Trust, which now trades on an estimated 2 per cent discount to cumulative income NAV."
Performance of trusts over 1yr
Source: FE Analytics
Darwall’s trust has underperformed both the Henderson portfolios, but Tuite Dalton says it could be a better bet for anyone sceptical the current surge will continue. The trust also has an outstanding long-term record.
UK smaller companies, on the other hand, look too expensive, the analyst cautions.
"Small and mid cap companies have also performed well in the UK, with the Numis Small Cap ex IT index up 36 per cent year-to-date, with the strongest investment company share price performance coming from 3i Group, up 70 per cent and Schroder UK Mid Cap up 52 per cent year-to-date," he said. "Both have benefited from a re-rating and are now arguably ripe for profit-taking."
Tuite Dalton says that technology trusts have also done particularly well, largely off the back of demand for US equities.
RCM Technology Trust has led the field, with returns of 53 per cent in share price terms against a gain of 28 per cent for the NASDAQ. NAV has risen 36 per cent, with a narrowing discount accounting for the rest of the returns.
Tom Tuite-Dalton says it now looks expensive on a 1.5 per cent discount and that investors may prefer to look at the much cheaper Herald Investment Trust, still trading on a 16 per cent discount.
The trust has been much more sedate over the past year, making 22.4 per cent in share price terms and 18.9 per cent in NAV terms.
Performance of trusts vs index over 1yr
Source: FE Analytics
Herald has a very different approach to RCM, however, focusing more on smaller companies and investing across media sectors as well as technology.
It has 61 per cent in the UK, which may explain in part why it has not seen the sharp appreciation of the US-focused RCM, which has large holdings in Google, Facebook and the like.
Emerging markets look very cheap at the moment, the analyst says, with Templeton Emerging Markets the standout choice.
"Emerging markets continue to receive bad press, much of it deservedly and performance numbers have disappointed relative to US and Japanese markets. Brazil and India have been particularly hard hit."
"Investors appear to be taking money out of emerging markets and buying European investment trusts to judge from the tightening of discounts among the European funds."
"We note that Templeton Emerging Markets is now trading at a wider-than-average discount of 12 per cent to cumulative inc NAV and that BlackRock Latin American is trading on a 14 per cent discount to NAV, its widest in over a year."
