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.
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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.
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