Want to invest in markets on the cheap? Check out these funds

Investment trusts let you pick up stocks cheaply

If you’re an investment trust fan, I’ve got good news for you. Discounts are starting to widen a little.

If that sounds like gobbledygook, I’ll put it another way: many investment trusts have become cheaper since January.

This is especially true for trusts that focus on smaller companies or emerging markets.

So if you’re planning to pump fresh money into the markets, investment trusts may well be the right vehicle for you.

Here are a few of the most tempting-looking options…

The big difference between investment trusts and other funds

An investment trust takes money from lots of investors and invests it on their behalf in companies and other assets. On that front, they’re not too different to unit trusts or Oeics (open-ended investment companies), which are the sorts of funds most people are familiar with.

The critical difference is that investment trusts are listed on the stock market. This means that the price of the trust moves independently of its underlying portfolio.

What does that mean? Well, if the value of a unit trust’s portfolio rises by 5%, the unit price will inevitably rise by 5% too. But with an investment trust, the share price won’t necessarily rise in line with the portfolio’s net asset value (NAV).

This is a good thing. It means you may get the opportunity to buy the underlying shares in an investment trust for less than they’re actually worth. In other words, the investment trust may trade at a ‘discount’.

So if an investment trust’s NAV is £1 per share, but the trust’s share price is 95p, the discount is 5%. In effect, you’re getting the portfolio 5p cheaper than if you’d bought it on the open market.

In the past, most investment trusts traded at significant discounts, but that has changed over the last year or so. In fact, I pointed out in January that investment trust discounts had narrowed to a record low 3.4%.

That was great news for anyone who had bought into investment trusts back in 2008/09 when discounts were nice and wide. But it wasn’t so good for anyone looking to invest in 2014.

So I’m pleased to see some signs that discounts are now starting to widen, particularly in unfashionable sectors such as emerging markets and smaller companies.


Sign up for a 4-week FREE trial of MoneyWeek magazine

MoneyWeek magazine signup

"The only financial publication I could not be without."
John Lang, Director, Tower Hill Associates Ltd.


For example, in January, the Templeton Emerging Markets investment trust (LSE: TEM) was on a 9% discount. That’s now widened to 11%, according to data from Hargreaves Lansdown.

In the smaller companies world, the BlackRock Throgmorton trust (LSE: THRG) was on a 7% discount in January. It’s now 12.5%. Meanwhile, the discount on the Henderson Smaller Companies investment trust (LSE: HSL) has widened from 10% to 12.5%.

Granted, a major factor behind the wider discounts is that share prices have been falling in these sectors. When share prices fall, you’d normally expect discounts to increase, as investors ditch the funds that invest in the sector even faster than they dump the underlying shares.

But these are all decent investment trusts managed by above-average stockpickers with good records, so I think these wider discounts present an attractive opportunity. It’s especially true for the Templeton Emerging Markets trust, whose manager, Mark Mobius, I really rate. If I wasn’t already a shareholder in the Templeton trust, I’d be very tempted to buy shares now.

Discounts are widening in other sectors too. The Perpetual Income & Growth trust (LSE: PLI) was on a 1% premium in January, but is now on a 1% discount. This trust is one of the best performers in the UK growth & income sector.

Then there’s the Scottish Mortgage investment trust (LSE: SMT). This global growth trust has been the top performer in its sector over the last year and has also done well over longer periods. In January, it was on a 4% premium, now it’s on a 1.4% discount.

Now, I’m not saying that either of these trusts are cheap. But at least they’re on a discount now. There’s no way I’d have bought the Scottish Mortgage trust when it was on a 4% premium, but I’m far more likely to consider it with the share price at a 1.4% discount.

What else do you need to know about investment trusts?

There are two other key points to understand about investment trusts.

Firstly, investment trust managers are able to borrow money to fund further share purchases for the trust. This means that the best fund managers can boost their performance by buying extra shares in their favourite companies.

Now, borrowing also increases risks. If you borrow money to buy shares that then tank, it’ll hit the trust’s performance hard. But history suggests that investment trust managers are pretty good at handling borrowed money (or ‘gearing’) – many studies show that they have outperformed their unit trust peers over long periods.

Secondly, investment trusts can hold back some of the dividends they receive from companies if they wish. A unit trust or OEIC must pay out all the dividends it receives to unit holders every year. But an investment trust can hold back some revenue, which means it’s easier to deliver a smooth record of rising dividends year after year.

So is it time to buy?

Investment trusts are not trading at amazing bargain levels right now. But they’re certainly more attractive than they were a few months ago.

And while discounts may widen further over the next couple of years – especially if markets fall – I doubt we’ll see a return of widespread 15% or 20% discounts again.

That’s partly because we should see more purchases via financial advisers. Until recently, financial advisers made more money if they focused on Oeics and unit trusts, but, thanks to regulatory changes, that’s no longer the case. So that should boost demand – in fact, it’s probably already doing so.

What’s more, investment trust boards now face more pressure to keep discounts on the low side. So trusts are more likely to buy back shares in future if that will stop the discount widening too much.

So overall, while they’re not screaming bargains, investment trusts look a lot more attractive than they did earlier in the year. I’m pretty positive about all of the trusts I’ve mentioned in this article. But you might also like to look at MoneyWeek’s investment trust portfolio which should give you some good ideas too.

This article is taken from our FREE daily investment email Money Morning.
Receive our thought-provoking investment email every weekday morning plus occasional promotions & become a smarter investor.

Please enter a valid email address

To sign-up enter your email address.


• Stay up to date with MoneyWeek: Follow us on TwitterFacebook and Google+

Our recommended articles for today

Asia is drying up – investors, pay attention

A freak weather phenomenon is spreading across Asia. Lars Henriksson explains what it is, and what it means for the region’s economies.

House prices: the biggest bubble since the last one

Britain’s housing market is booming. Bengt Saelensminde looks at what’s driving the mad rush to buy, and explains why it could all end in tears.

  • mikeT

    Is this “cheapness” a function of how much the fund has borrowed ie just a reflection of additional risk?

  • Marko

    Hansa trust has a ridiculous discount of 25% to NAV.

  • mikeT

    @Marko How leveraged is Hansa compared to peers?

  • MarkN

    Moneyweek consistently advises purchasing ITs on discounts yet has been talking up HICL Infrastructure in the last week or two despite it trading at a premium of 15%!

    And where is the update on the IT portfolio Moneyweek put together? I thought a 6 monthly review was promised?

MoneyWeek magazine

Latest issue:

Magazine cover
Heading higher?

Or are house prices set to fall?

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues

'Would you rather upset God, or have Him just ignore you?'

In the first of three interviews with Merryn Somerset Webb, Hugh Hendry, manager of the Eclectica Fund, talks about what it takes to be a good hedge fund manager – and how he learned to stop worrying and love central banks.


Which investment platform?

When it comes to buying shares and funds, there are several investment platforms and brokers to choose from. They all offer various fee structures to suit individual investing habits.
Find out which one is best for you.


24 November 1972: the 'DB Cooper' hijacking

Today in 1972, a man calling himself Dan Cooper parachuted from a hijacked Northwest Airlines Boeing 727 with $200,000 in cash. He has never been found.