The genuine bargains in the investment-trust sector

A discount to net asset value should never be the primary reason for buying this type of fund, says Max King. These seven, however, look too cheap and boast encouraging long-term records

Vietnam is one of the bright lights of the developing world

Everybody loves a bargain. The investment-trust sector appears to offer one of the best bargains available to investors: trusts whose shares trade at a significant discount to net asset value (NAV), the value of the underlying portfolio. These offer investors the prospect of enhanced returns as discounts to NAV narrow.

If you buy a trust on a 15% discount to NAV, and the discount disappears as the price rises to par, you have made 15% before capital gains or dividends on the underlying portfolio of assets.

A discount to NAV offers downside protection too, as there is limited scope for the discount to widen further. Looking for trusts trading at an anomalously high discount is eternally popular. But does the strategy actually work?

Not as well as people think. Discounts can always widen further, although that should prompt the directors to take action. They can either buy back shares at a discount, thereby adding value for remaining shareholders, or switch managers to one who commands more confidence.

Alternatively, they can wind up the trust in whole or in part and distribute the proceeds to investors. The downside protection should work, but it may take time and performance in the meantime may be disappointing.

Equally, there is no certainty about the timing of a discount narrowing, so the gain from it may be dwarfed by the underlying movement in the market or the manager’s performance. A narrowing discount does not guarantee great returns.

Cheap for a reason?

Many trusts that trade at wide discounts do so for good reason. The shares may be illiquid, probably because the trust is small and its costs high; the asset class might be out of favour with investors; the manager may have a poor record and the replacement, if there is one, no better; and the directors may be slow to react, perhaps because a dominant shareholder likes things just the way they are.

The sector’s average discount was above 20% in decades past, but was negligible at the start of last year. It is now 3.7% and the average for the year has been 3.3%, so discounts have narrowed significantly over the long term, but widened a little recently.

The number of trusts now on discounts above 15% is small. Most of those should be avoided by all but the experts and activist investors prepared to buy large holdings and press for change. Still, there are

a few larger trusts that stand out as being attractive. These well-established trusts have been neglected by investors who have rushed to buy the more recent innovation-heavy new launches, which trade at large premiums to NAV, but neglect the established funds.

Rich pickings in private equity

A good number of the attractive trusts are in the listed private-equity sector, where performance over all time spans has been excellent. Moreover, NAVs are historic and nearly always conservative. ICG Enterprise

performance has improved since management moved to Intermediate Capital in 2016. Its annualised five-year total return to mid-2021 was 16%. Exits from 34 investments in the first half at an average gain of 26% over the valuation of the investment on the group’s balance sheet suggest that the NAV is significantly understated.

The £1bn portfolio, 40% of which is now in North America, is moving steadily away from third-party investments (now 52%) to those managed by ICG itself (27%). “ICG gives us access to a very strong deal flow,” says Oliver Gardey, lead manager. “This is a very good environment for new investments as well as for disposals.” The top 30 investments are valued at 14 times historic cash flow, “a significant discount to companies in public markets”, having generated 18% growth in revenue and 26% in cash flow in the last 12 months. The trust’s shares yield 3.3%.

The main listing of Canadian General Investments (LSE: CGI) is in Canada, but the shares are also traded in London. It’s off the radar of most UK investors, so the shares trade at a discount to NAV of 35%. The Canadian tax rules stipulate that CGI pays tax at around 20% on both income and capital gains, but that tax is refunded when distributed to shareholders: the group distributes realised capital gains as dividends along with the usual kind of payout. The yield on CGI’s shares is 1.7% from 2020 income dividends, subject to a 15% withholding tax, and 0.6% from capital dividends, although this year’s payout is likely to be much higher.

Top holdings include some US names with Canadian listings, such as semiconductor maker Nvidia and Amazon as well as Canadian ones such as Shopify, Lightspeed, an e-commerce software maker, and TFI International, a transport and logistics group. Miners such as Franco-Nevada and First Quantum Minerals also feature in the top ten, as do West Fraser Timber and Canadian Pacific Railway, but no financials. CGI has multiplied investors’ money 14-fold in the last 20 years and returned an annualised 20% in the last five years.

Profiting from the plunge

The shares of Pershing Square Holdings (LSE:PSH) have risen by 10% in recent weeks owing to appreciation of a coup by US investor Bill Ackman, who owns 25% of this fund and runs its parent company, Pershing Square Capital. He secured a sizeable stake in Universal Music at a very attractive price prior to its recent listing.

Yet the trust’s shares still trade on a discount to NAV of 26%. The portfolio has returned 163% in the last three years, including 70% in 2020, when Ackman anticipated the stockmarket meltdown. Having protected investors by betting heavily that spreads between corporate and governments would widen sharply, he cashed in at the low and reinvested in equities.

The portfolio is highly concentrated with the top five investments typically accounting for over 60% of the portfolio and the top ten for 80%, but although it is classified as a hedge fund, its portfolio, excepting forays into derivatives to protect the downside in times of strife, is long-only.

Managed for 40 years by veteran Christopher Mills, North Atlantic Smaller Companies (LSE: NAS), with £900m of assets, trades at a 23% discount to NAV. The five-year investment return has been 116%, ahead of all the global trusts except the Baillie Gifford ones and Lindsell Train, while the annualised return since inception has been 13.8%.

About 16% of the portfolio is accounted for by sister trust Oryx International, which trades at a 3% discount to NAV and has multiplied investors’ money twelvefold in 20 years. At the last year-end, 14% of the NAS portfolio was accounted for by private equity, presumably conservatively valued. The remainder of the portfolio is in “special situations”, in which Mills, as one of the most successful and feared activist investors in the UK, is keen to bring about change. Each report features a major battle, indicating that Mills is prepared to fight if persuasion fails to work. Mills owns 27% of the equity and NAS has been steadily buying back shares.

A promising property play

Property investors have yet to forgive BMO Commercial Property Trust (LSE: BCPT) for slashing its dividend last year. Although recovery is under way and, based on a more affordable dividend, the shares yield 4.2%, they still trade at a 22% discount to mid- year NAV.

Over three years, the share-price return has been -31%, but the investment return only -3%. Over 20% of the £1.2bn property portfolio is accounted for by St Christopher’s Place Estate, just off Oxford Street in London. It comprises 150 lettable units of shops and restaurants , office suites and flats, and was badly hit by the pandemic.

It should recover now that lockdown has ended and tourists are returning. Over half the portfolio is in London and Southeast England and over 40% in offices. The sale in September of a London office block for £145m, 11% above valuation, increased confidence in valuations, as have other recent sales. These sales will reduce debt of £310m at the start of the year and facilitate new investments. There has been a stream

of good news from the rest of the portfolio, making it likely that the next valuation will show a useful increase. BCPT has been buying back shares

An emerging-market star

Vietnam is one of the bright lights of the emerging world, yet the Vinacapital Vietnam Opportunity Fund (LSE: VOF), with £600m of assets, trades at a 23% discount to NAV. Around 70% of the portfolio is in listed equities, 14% in unlisted (but traded) equities, 12% in private equity and 4% in bonds and cash. A summer lockdown will have hampered the firms in the portfolio, but underlying growth is strong. Vietnam is benefiting from developed-world governments’ growing distrust over trade with China and from a shift in manufacturing to Vietnam to exploit lower costs. Investors’ scepticism looks unjustified.

Finally, Caledonia Investments (LSE: CLDN) is classified as an international trust although its focus is on private equity. Its shares trade on a 22% discount, but performance has picked up strongly in the past year, with an investment return of 28%. About 28% of the £2.4bn investment portfolio is invested in direct private equity; 30% is invested in third-party private- equity funds, 30% in direct equities (“we are long-term owners of companies, not traders”) and 12% in cash. The funds give Caledonia exposure to sectors and regions not covered by the other parts of the business, while the cash has enabled CLDN to enhance NAV by buying back shares.

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