Murray International, Capital Gearing and Aberdeen Asian Income all saw disappointing returns in 2013 exacerbated by a premium shrinking closer to par.
The analysts have highlighted a number of trusts where they think there is value to be found and a catalyst for their discount to narrow.
“A year ago, we highlighted that a number of equity funds were trading on premiums that appeared unsustainable,” they wrote.
“There was a threat that investors would suffer disappointing returns simply from an erosion of the premium, which would be exacerbated if NAV performance was also dull.”
“During 2013, Murray International (4.1 per cent total shareholder return), Capital Gearing (-9.0 per cent) and Aberdeen Asian Income (-9.2 per cent) were all laggards.”
Performance of trusts vs index in 2013
Source: FE Analytics
“Even though they all have impressive long-term track records, the premiums reached at the start of 2013 proved to be unsustainable.”
“We also highlighted the high premium on Edinburgh IT, and although we did not predict Neil Woodford’s resignation, this highlights that premiums can be eroded for reasons other than performance (the NAV rose 30.5 per cent during 2013, but the share price just 23.1 per cent).”
“Historic evidence suggests that high premiums are unsustainable, which implies that investors buying stocks on high premiums will endure disappointing total returns over the medium-term.”
“This is partly because premiums tend to lead to share issuance, but also because asset classes come in and out of favour, and the performance of star managers often starts to wane.”
“This is either because their investment style/approach falls out of favour or because they end up running too much money.”
Monks
Numis says that global growth trusts are good long-term savings vehicles for the retail investor.
The analysts highlight the £902m Monks trust, run by Gerald Smith and Tom Walsh for Baillie Gifford. The trust is sitting on an 11.6 per cent discount, according to AIC data. Ongoing charges are low, at 0.59 per cent.
It has made NAV gains of just 12.9 per cent over the past three years compared with gains of 29.27 per cent from its FTSE World benchmark. Share price returns were 13.98 per cent.
Performance of trust vs sector and benchmark over 3yrs
Source: FE Analytics
“It has a far more diversified portfolio of growth stocks than its stablemate, Scottish Mortgage, and performance in recent years has been dull, partly because the approach has not been favoured by the market’s focus on defensive income stocks, but also because of the weak performance of resources stocks.”
“Gerald continues to manage the fund without being constrained by market weightings. However, Baillie Gifford has taken steps to address the underperformance, including the appointment of Tom Walsh as deputy manager, and changes to the stock-selection process.”
“This has involved reducing the number of holdings and cutting exposure earlier if investment themes do not play out as expected (for example gold miners).”
“The manager continues to have a bias to growth companies with the potential to deliver superior operational performance. Its largest holdings include IP Group, Sky Deutschland and Harley Davidson.”
“NAV performance has improved and we see scope for the discount to narrow if this is sustained.”
British Empire Securities
The analysts also think there is scope for a re-rating of the shares of the £744m British Empire Securities trust.
The trust, managed by John Bauernfreund and John Pennink, is trading on a discount of 12.5 per cent, with a 2.1 per cent yield. It has ongoing charges of just 0.71 per cent.
It is another to have suffered dull recent performance, with the share price appreciating only 6.91 per cent over the past three years, according to data from FE Analytics.
Performance of trust vs sector and benchmark over 3yrs
Source: FE Analytics
However, Numis notes that the long-term track record, achieved by buying into funds or companies on wide discounts, is good.
“Recently it has lagged behind its peers, but we believe the best time to invest in British Empire is when discounts within the underlying portfolio are wide, with value opportunities for the manager to exploit,” the analysts said.
“The current underlying discount of circa 30 per cent is tighter than the trough of 39 per cent reached in September 2011, but still offers value, in our view.”
“British Empire has an interesting mandate that is clearly differentiated from other Global Growth funds, and we believe it remains an attractive investment.”
“The portfolio is currently biased towards holding companies, and the largest investments as at 30 November were Vivendi at 7.6 per cent, Investor AB at 5.6 per cent, Jardine Matheson at 5.4 per cent, Groupe Bruxelles Lambert at 4.6 per cent, Aker at 4.4 per cent, Sofina at 3.6 per cent, First Pacific Co at 3.4 per cent, and Dundee Corp at 2.8 per cent.”
JP Morgan Japanese
Another trust that the analysts continue to believe will benefit from a re-rating is JP Morgan Japanese, managed by Nicholas Weindling.
Weindling explained the rationale behind his current portfolio in a recent FE Trustnet article.
The trust is trading on an 8.7 per cent discount, which Numis says could narrow. Investors should consider switching from the Baillie Gifford Japan fund, which they rate highly but is on a 6.1 per cent premium, they say.
“Baillie Gifford Japan has been our favoured vehicle in this market and it has delivered stellar returns,” they said.
“However, we believe that the current premium of 6 per cent leaves the fund's share price vulnerable to any setback in investor sentiment.”
“Historically, JP Morgan Japanese’s performance has been disappointing. However, this has gradually turned around under the management of Nicholas Weindling, who took over in late 2007.”
“He focuses on quality companies in secular growth markets rather than 'old Japan'. The NAV rose 45 per cent in 2013 versus an increase of 25 per cent for the Topix index (in sterling) helped by a shift from defensive, higher-yielding companies to more cyclical stocks (banks, real estate and construction) at the start of the year.”
“JPM Japanese is the largest and most liquid London-listed fund investing in Japan, and we see scope for a further re-rating from the current discount of 8 per cent as the turnaround in performance is recognised more widely.”
The trust has ongoing charges of 0.78 per cent.
Advance Frontier Markets
Numis says there is value in some of the more mainstream emerging market trusts such as those run by Aberdeen, even though their style is out of favour at the moment.
However, the analysts point out that frontier markets are going through a period of strong performance, and the £95m Advance Frontier Markets portfolio looks good value on a discount of 10.2 per cent.
This is compared with a 3.7 per cent premium on the BlackRock Frontiers fund, which the analysts say could prove unsustainable.
However, performance on the BlackRock fund has been superior: the trust has made 31.3 per cent in NAV terms over the past year compared with just 19.2 per cent for the Advance fund.
In share price terms, the BlackRock fund is up 45.95 per cent, helped by a growing premium, with the Advance fund up 22.52 per cent, closer to the returns of the MSCI Frontier Markets index.
Performance of trusts vs index over 1yr
Source: FE Analytics
“Frontier Markets delivered strong performance in 2013, and we continue to believe that this asset class is interesting, benefiting from strong GDP growth, favourable demographics and low levels of debt.”
“BlackRock Frontiers invests directly into the larger companies within the universe, while Advance Frontier Markets invests through 'best of breed' open- and closed-ended funds that provide access to experienced locally based managers.”
“Both funds have offered investors the opportunity to exit at NAV less costs in 2016. At present, there is a strong valuation argument for Advance Frontiers.”
BlackRock’s better performance comes at a price, however: it has ongoing charges of 2.83 per cent inclusive of a performance fee, compared with 1.54 per cent from the Advance fund.