Beware of the free lunches on offer

The economic downturn means there are some massive discounts around these days and not just on the high street. Plenty of big bargains are on offer in the investment-trust world, too. Some of the discounts to net asset value (NAV) the gap between the share price and the underlying book value of the portfolio have hit traffic-stopping proportions. Nowhere is this more apparent than in the property sector.

For example, the Invista European Real Estate fund now trades at a discount of around 67%. That's like buying £3 of assets for £1. In fact, for the European direct property sector as a whole, you can pick up £2.50 of NAV value for £1, according to data from Wins Research. And the British direct property sector is in more or less the same boat, selling on an average 43% discount to published net worth, even though the latter has dropped by 11% over the last six months. "The current discounts in property are a buying opportunity", says fund manager Daniel Lockyer of the iimia Investment Trust.

But as ever, there's a health warning. These big discounts may not be quite the 'free lunch' they would appear to be at first glance. Stockmarkets aren't entirely stupid, after all. The big discounts may simply reflect the fact that prices in the property sector are likely to fall further than many commentators are currently allowing. What's more, some of the bigger property-sector discounts are arising for a very good reason: high debt.

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Lockyer tells the FT that investors need to look beyond the bald numbers. "Anything that's highly geared I would tend to avoid," he says. For example, while the Invesco Property Income Trust trades on a 63% discount, as of 31 March it had a gross loan-to-value (LTV) ratio of 69.5%. This has risen as commercial property prices have dived, forcing it to sell assets and ask its lenders temporarily to raise its maximum allowed LTV ratio to 75%.

And investment trusts in other heavily discounted sectors, such as UK High Income, which sells on a 21% discount, Global Smaller Companies on 17% and, in particular, Private Equity Direct on 25%, may be warning us more about what's going to happen to the underlying firms in the portfolios than throwing up a buying opportunity. If stockmarkets drop some way further, those discounts won't protect investors from more pain. But that doesn't mean there aren't any opportunities out there.

As we've frequently said before, Japan is our favourite developed market. The Daily Telegraph likes the look of the Schroder Japan Growth Fund (LSE:SJG), managed by Andrew Rose, which is on a 14% discount. The fund is "focused on solidly run, reasonably valued companies based on sustainable cash flows". Another, better-performing trust is the Baillie Gifford Japan Trust (LSE:BGFD), which has outperformed the Japan Smaller Companies index over the past three- and five-year periods and is currently on an 8% discount.