A total of 37 out of 38 investment trust sectors are trading at a discount, according to the AIC.
Widespread discounts are a sign of investor risk aversion and discounts on income trusts have narrowed as investors turn to dividends.
Laith Khalaf, head of investment analysis at AJ Bell: “It seems even investment trusts are getting in on the Black Friday craze this year, with almost all sectors trading at a discount, according to data released by the AIC. Just as significantly, the discount on the average investment trust has widened by more than 10 percentage points since January. The fact that almost all investment trust sectors are trading at a discount, and that discounts have widened so much this year, is a sign of poor market sentiment and risk aversion amongst investors. The global economy is tilting downwards, geopolitical risks are high, and a tectonic shift in monetary policy is undermining confidence in asset valuations, so it’s entirely understandable that investors might be assuming a startled tortoise pose.
“However at times of deep uncertainty like this, contrarian investors might be thinking about going bargain hunting. It’s often rewarding in markets to be greedy when others are fearful, though given the current fears stalking the market have unpredictable political, economic and monetary dimensions, it’s probably a good idea to hedge your bets by drip-feeding money into the market gradually, perhaps through a regular savings plan.
“It’s important to recognise that simply because an investment trust is trading at a discount, it may not be a screaming bargain. A trust may habitually trade below its net asset value, so investors should compare the current discount to a historical average, to get an idea of how cheap the trust really is. Indeed it’s notable some trust sectors have actually seen their discount narrow over the course of this year, which means they aren’t as attractively priced as they were. The sector averages themselves are also only an indication of value, because there can be a wide dispersion of discounts within each sector and even some trusts trading on a premium. For instance, the North America sector carries an average discount of -26.5% according to the AIC, but discounts within this sector range from JP Morgan American on a discount of -2.2%, through to Pershing Square Holdings on a discount of -32.8% (source: Morningstar). So investors looking for bargains need to go out with a line and pole rather than a trawling net.
“Investors should also be extra vigilant of funds which are partly or predominantly invested in illiquid assets like property, private equity or infrastructure, because the underlying net asset value may not be right up to date. These assets’ valuations are also open to a greater degree of subjectivity than a publicly listed share, whose market price is revealed many times a minute through the activity of buyers and sellers on the stock exchange. Putting a value on an office block isn’t quite as straightforward. Investment trusts are generally a much preferable way of investing in illiquid assets like property than an open-ended fund, because they don’t have to try to liquidate holdings to meet outflows, but investors do need to be a bit switched on about valuations and discounts.
“Investment trusts are also handy tools for investors looking for a smooth and regular income, because the investment trust structure allows them to continue to pay dividends in poor years, and top up their reserves in good years. An investment trust won’t receive any more dividends than an open-ended trust invested in the same share portfolio, but it will be able to spread those dividends out a bit more, allowing income investment trusts to pay a more predictable income stream. The average discount in the UK Equity Income and Global Equity Income sectors have actually narrowed this year, which suggests an uptick in interest in dividends as we enter an economic slowdown, when one in the hand might be worth more than two in the bush.
“Investors should also ensure they are comfortable with the risks inherent in the structure of investment trusts. The fact trusts can trade at a discount or a premium to their net asset value adds to their volatility. Investment trusts can also borrow to invest, amplifying returns in bull runs and increasing losses in falling markets. Over the long term borrowing to invest should prove a tailwind, but it can lead to more heavy price falls when markets take a dive. Indeed with interest rates rising, investment trusts looking to raise debt finance in the next few years are going to find it a lot more expensive to do so than they have for some considerable time.
“Buying an investment trust on a hefty discount can be an extra kicker of return for investors, but the market and the portfolio will be the key drivers of returns, so investors should pay attention to a trust’s performance and investment philosophy when doing their research, as well as the annual charges levied. Given the forthcoming cuts to dividend tax and capital gains tax allowances, investors should also seek to wrap their investment trusts within a SIPP or ISA wrapper where possible.”
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