Why it's a good time to cash in on commodities

Buy into an investment trust now and you could snap up shares in companies you like below market value. We reveal where to find discounted funds in the still-attractive commodities sector.

You won't hear much about investment trusts from the typical financial adviser, mainly because they don't pay any sales commission. But shares in these stock-exchange listed trusts should be of interest to every funds investor. Not only do they charge lower fees than unit trusts, but if you buy at the right time, they give you the chance to snap up shares in companies you like at below face value. And right now is just such a time.

"In periods of market turmoil, there can be a disconnect between a closed-end fund's [investment trust's] stock performance and that of its underlying net asset value," says Martha Metcalf, a managing director at Credit Suisse, in The Wall Street Journal. In other words, as investors sell shares in an investment trust, its value falls below that of its underlying portfolio this is known as trading at a discount.

If a trust is on a 10% discount, an investor can buy £1 of assets for 90p. The potential benefits are obvious. If you buy when the market is feeling pessimistic, you can get the shares cheap. When sentiment turns, not only do you benefit from rising underlying share prices, the discount is also likely to narrow, delivering an extra boost to profits. And these days, trusts on large discounts are less and less likely to be left at those levels. Large investors called arbitrageurs often pounce when discounts widen too much, forcing the management to act either by buying back shares or winding up the fund and paying out the net asset value to shareholders.

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Sometimes discounts are entirely justifiable. For example, UK commercial property trusts are trading on a 15% discount to net asset value compared with premiums at the start of the year. And given weak returns in the commercial property market, the tough times may well continue. But market volatility has also affected trusts in more attractive places. City Natural Resources Fund (CYN) is on a discount of 6.5%, while Graham Birch's Merrill Lynch World Mining (MLW), which invests in miners like Rio Tinto and Impala Platinum, is now on an 8.2% discount. They've returned 305% and 428% respectively over the past five years. "Unless you are very pessimistic about the market, there's a lot of value to be found in many sectors," says Mark Dampier of Hargreaves Lansdown on Interactive Investor. "Provided you're not expecting an instant turnaround." In the UK and US, we don't. But as Eastern economies continue to grow, it's still a good time to cash in on commodities.