Investing in closed-end strategies can sometimes be challenging for investors given the premium/discount factor. Funds can often trade at a different price than the underlying holdings presenting bargains or making them more expensive than they should be.
In the below article, research firm Kepler Trust Intelligence looks at four closed-end strategies – Lindsell Train, Syncona, 3i and Independent Investment Trust – and considers whether these investment companies are worth their hefty prices or are the victims of ‘excessive optimism’.
Each of the trusts are on trading at large premiums to net asset value (NAV), investing more than 50 per cent of their holdings in publicly-traded assets and have a good track record of performance.
“Within the world of investment trusts, 'excessive optimism' is more easily measured in terms of premiums to NAV. This is particularly the case where the majority of a trust’s assets are themselves quoted,” noted analysts at Kepler.
There are currently 90 trusts that trade on premiums and 55 per cent of these invest more than half of their holdings in either illiquid or unlisted assets, the research house said.
“With these trusts, over-enthusiasm is perhaps a little less easy to gauge – it is entirely possible that either valuations have moved on since the last official valuation, or that the board is being conservative in its valuations,” the research firm noted.
“Either way, each is likely to have its own story and a premium is not necessarily an indicator of excessive optimism.”
Indeed, paying anything over a modest premium is “setting yourself up for a fall”, according to Kepler.
As such, Kepler has examined the trusts in closer detail to find out whether they are fairly-valued.
Lindsell Train Investment Trust
Lindsell Train Investment Trust is managed by FE Alpha Manager Nick Train and has been trading on an average premium to NAVE of 31 per cent over three years.
Currently, the £235.5m trust is trading at a premium of 43.9 per cent, which Kepler described as “ear-bleeding”.
Performance of trust vs sector over 10yrs
Source: FE Analytics
Kepler analysts said they agreed with the trust board, which maintains that the premium is unwarranted and cautions new investors about buying shares at a premium which could disappear if markets decline or the fund performs badly.
The trust has been a strong performer in both the short and long term. Over 10 years, it has delivered a total return of 953.74 per cent and is the best-performing fund in the IT Global sector, which had an average performance of 188.33 per cent.
It is also the sector’s top-performer over three and five years, while it is the second-best trust in the sector during the past 12 months.
Using the valuation of the 25 per cent stake in its own management company, Lindsell Train, as an indicator, Kepler said that the board of Lindsell Train Investment Trust is undervaluing the stake in its own management company relative to quoted peers.
Kepler caveated: “On the other hand, in the case of Lindsell Train, investors are currently materially overvaluing the stake in the manager.”
Because of this premium, Kepler suggested that Majedie Investments may be an alternative to the Nick Train’s trust.
Using the same valuation metric, Majedie Investments is also being undervalued by its board of directors relative to peers. However, because it trades at a 12.4 per cent discount to NAV, it is clear that the market also undervalues the trust.
“Is this discount justified? We don’t think so – clearly, each business will have a different trajectory and risks, but Majedie certainly has a more diversified product suite and with its many managers and strategies, considerably less 'key-man' risk,” said Kepler.
Syncona is a trust that invests in life sciences companies and works with Cancer Research UK and the Wellcome Trust. The trust currently trades at a 38.5 per cent premium, which bothers the Kepler Trust Intelligence analysts.
“There is no doubting the expertise and embedded knowledge within the Syncona team, and that this could over time lead to superior returns,” they said.
“However, at this stage in the stock market cycle and at the current premium, the short-term risks of a re-rating might be considered higher than the long-term potential for NAV progression.
“Certainly, investors are paying away a lot of the upside to get on board at the current price.”
In the long term, the fund has underperformed the average IT Biotechnology & Healthcare peer and over 10 years, the trust is up 189.75 per cent, while its average peer has gained 220.13 per cent.
Performance of trust vs sector over 10yrs
Source: FE Analytics
In recent times, however, it has been a good performer and is up 118.81 per cent over three years, while its average peer is up 43.12 per cent.
Kepler proposed an alternative trust for those investors wishing to get exposure to early-stage life sciences businesses, Woodford Patient Capital Trust, which trades on a 13.3 per cent discount.
The research house said that Woodford Patient Capital Trust’s largest holding, Autolus, is 38 per cent owned by Syncona, therefore “illustrating that both companies are fishing in similar ponds”.
While acknowledging that performance of the trust – managed by Neil Woodford –has been uninspiring and that investing in it might be considered a leap of faith, the unlisted portion of the portfolio has generated positive NAV returns.
Indeed, the trust has underperformed its average IT UK All Companies peer by approximately 50 per cent since its launch in 2015 and has made a loss of 18.86 per cent.
Kepler added: “While some of the criticism that Neil has attracted is fair, and there have been missteps, the temptation has been strong for observers and competitors to attack the man who was previously the acknowledged stand-out performer among his peers.
“We think the fortunes of the trust could change quickly if a few good results come through and the NAV gets back to 100, and we would not be surprised if it were to trade close to par or on a premium again.”
3i
Next on the list is the FTSE 100-listed private equity investor 3i, which is currently trading at a 19 per cent premium to NAV.
Over 10 years, the trust has outperformed its average IT Private Equity peer but underperformed the FTSE Small Cap ex IT by roughly 40 per cent. However, over three- and five-year time frames, the trust is the sector’s best performer.
This strong performance can be largely attributed to one holding in the trust, Action, which represents nearly 30 per cent of the NAV of the trust, said Kepler.
Performance of trust vs sector and benchmark over 10yrs
Source: FE Analytics
The fact that one holding represents such a large portion of the trust, paired with a big premium, are the biggest risks facing shareholders in the trust, it added.
“If Action’s growth ambitions were somehow curtailed, it is not difficult to imagine that its valuation might be reduced, but also that some of the excitement in the 3i share price might disappear – with painful consequences for shareholders,” said Kepler.
If investors want “a more balanced and arguably more sustainable” exposure to private equity, Kepler suggested they might consider the following trusts that are all trading at discounts: ICG Enterprise Trust, NB Private Equity Partners and Standard Life Private Equity Trust.
Finally, Independent Investment Trust is a trust that Kepler believes is now trading at an interesting level.
It traded on a premium of roughly 20 per cent throughout the summer this year but after a period of weaker performance, it is now down to a smaller premium of 6.1 per cent.
It is a strong performer, however, and over one, three, five and 10 years the trust is a top-quartile performer in the IT Global sector.
Kepler said: “With a portfolio of 23 stocks relative to the peer group average of 80, Independent Investment Trust has performed handsomely over both the short and long term, and exemplifies the amplifying effect that having a concentrated portfolio can have on performance.”
Should the trust return to a chunky premium, however, Kepler said Strategic Equity Capital and Jupiter European Opportunities are some good replacements that also run a concentrated portfolio and have an idiosyncratic manager.