Investment trust discounts can provide opportunities
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Markets are skittish again. By my reckoning we are now on the fifth reversal for the all-important US market since January, as measured by the S&P 500 index. The index is now down 20 per cent on its level at the beginning of this year.
It’s not unreasonable to expect another lunge downwards, perhaps by another 10 per cent — but that assumes there aren’t any additional black swans, grey rhinos or unforeseen bumps in the middle of the night to take it even further south.
Still, nasty, volatile and brutish markets represent an opportunity for the diligent adventurous type, especially in the investment trust space.
These listed investment funds have the great advantage that they are easily tradeable, can borrow to enhance returns and are usually run by highly regarded managers. The downside is that discounts can also emerge between the share price and the value of the fund (expressed as its “net asset value”).
Arguably, big discounts are a double-edged sword. They can represent great value if you are invested in a fund where a future catalyst can narrow that discount. But a chunky discount can grow even bigger if markets wilt and investors run for the hills.
In times of real stress, discounts of 40 to 60 per cent are not uncommon among certain investment trusts. This is exactly what we find at the moment, where discounts have widened across the board compared with the 52-week average.
Take the most popular segment, global equity funds. According to data from fund analysts at Numis, the average 52-week discount for the 19 funds in this niche was 5.7 per cent, whereas the average is now running at 9.1 per cent. The hugely popular Scottish Mortgage has moved to a 10.4 per cent discount versus a 52-week average of 3.1 per cent.
But these discounts pale by comparison with those of some adventurous funds, which are increasingly worth further research. Take Molten Ventures (the old Draper Esprit), a venture capital business which currently trades at a cavernous 63 per cent discount. That huge gap makes some sense because its portfolio of earlier-stage private investments is probably only in the first stages of a brutal venture capital bear market.
But Molten is a smart business and there comes a point where that discount is likely to turn sharply. That’s not imminent in my view (and in fact could steepen further) but in the medium term I’d happily bet on Molten’s portfolio of high-growth businesses.
Georgia Capital is a very different beast. It invests not in the US southern state, but the Caucasian republic of the name. You might think that the 61 per cent discount is deserved because of its proximity to Russia, with which it has fought a bitter war in the past.
But the Georgian economy is booming, with real GDP up 10.4 per cent in 2021. This fund’s private equity investments have never had it so good, with valuations consistently marked up in recent reports. Either that 61 per cent discount is a big red flag warning of future troubles ahead or the discount is just too big. I’m happy to give it the benefit of the doubt for now.
The GRIT Real Estate Income fund invests in commercial property across Africa and currently trades at a 63 per cent discount. Its blue-chip tenants include the US government and it has just refinanced a big chunk of debt. It has also just updated its forecasts for the current year and expects the target dividend yield to hit 13.59 per cent, based in part on a portfolio of around $850mn that is expected to increase by just under 7 per cent in value.
In truth, the fund has never been that popular with UK-based investors, but I think there could be real upside here if it gets its act together and boosts dividends.
The listed private equity space is full of funds trading towards the furthest end of their discount range, with an abnormally large number of quality funds trading at huge discounts. To some extent those discounts are justified because I think we are only midway through a brutal private equity revaluation process which could last another year.
But there comes a point where the size of the discount relative to long-term performance becomes untenable. I think this applies to funds of funds such as HarbourVest Global PE (at a 49 per cent discount) and Pantheon International (46 per cent discount). I’d also argue that Oakley Capital Investments’ share price on a 39 per cent discount is becoming increasingly irrational, especially considering the quality of its portfolio.
I’d also make the same argument for two shipping funds I’ve mentioned before in these columns: Taylor Maritime and Tufton Oceanic. These trade at around the 20 per cent discount mark, despite producing hugely impressive returns in recent years. Investors seem worried about the shipping sector cooling rapidly and leasing rates collapsing but there is no evidence that this is having a huge impact on these funds’ revenues. In fact, the valuation of their specialist ships seems to be increasing.
Some deep discount plays involve funds that have slightly fallen out of favour. I’d put Hipgnosis Songs in this category, trading at a 29 per cent discount. For many years this fund — which buys music rights — was the toast of the city but in recent months sentiment has turned bearish, not helped by pointed questions about how its portfolios of songs are valued.
I’ve become a little cagey about this fund for the same reason, but at the current discount I’m less worried than I used to be, because of that margin of safety. Also, Hipgnosis is now large enough that it could in theory become an attractive takeover target for a big financial player looking to buy a ready-to-go portfolio of high-quality music rights.
Last, but by no means least, we come to the property sector, and another arguably fallen star, Tritax Big Box Reit. This is one of the biggest players in the logistics, big box warehouse space and at one stage was hugely popular with investors who were sold on the idea of ecommerce expansion. But sentiment has turned sharply in the logistics warehouse market and investors are now worried that Amazon is no longer so keen to expand in Europe.
There is also a real concern that prices for these huge warehouses have become inflated — but at some stage the bad news is in the price and Tritax is currently at a 33 per cent discount. There could be more bad news on valuations in this huge segment and thus I wouldn’t be racing out to buy the shares right now, but I’d keep a close eye on this fund.
The same goes for other property plays such as the Regional Reit which invests in, you guessed it, regional commercial property in the UK, and the Schroders European Real Estate fund, which invests in a handful of developments in the big continental metropolitan centres.
We can all draw up our own shortlist of reasons not to buy commercial property at the moment, especially in the UK regions and the continent, but both funds are highly regarded, with high-quality portfolios that have so far produced more than decent results.
The Schroders fund trades at a 26 per cent discount and the Regional Reit at 27 per cent. As with Tritax, that discount could widen if markets stumble, but soon these discounts will become very enticing.
My message is that we’re probably not quite at the point of capitulation for investment trusts — but we may not be far off. And if some of the discounts I mention widen even further, I think the upside could be worth the risk.