Bargain hunter: Bag a double discounter while you can
29th September 2016 12:07
Those who like investment trusts because they offer a tax-efficiently managed spread of holdings, often at a discount to their combined value, should not overlook the various closed-ended funds of funds (FoFs) available.
Scattered across several Association of Investment Companies (AIC) sectors, some trade at close to their net asset value (NAV) per share, but others are on significant discounts. These offer investors the chance to enjoy a double discount - the discount on the trust itself and that on its underlying holdings.
If both the trust's discount and the average discount on its holdings narrow at the same time, as happened for many closed-ended FoFs over the years following the financial crisis, investors should be well-rewarded.
Conversely, if discounts across the close-ended sector widen, trusts that invest in equities via other trusts are liable to be harder-hit than those that invest directly in equities.
Holdings may be well-run trusts in out-of-favour sectors, or resurgent specialist trustsThis occurred in the first half of 2016, undermining the previously good performance figures of closed-ended FoFs such as , and .
However, discounts do not widen indefinitely, and their weakness earlier this year means the closed-ended FoFs now have more attractively priced investment opportunities.
These could be in well-managed trusts in sectors that have slipped from favour, such as Europe and UK smaller companies, or in specialist trusts regaining a following, as has been the case with emerging market and mining trusts.
Or they could be in trusts or holding companies where there is scope for returns to be transformed by corporate governance initiatives or restructuring measures, with closed-ended FoFs such as and ready to push hard for such changes.
For those wanting a managed exposure to mainstream equity markets, the most suitable FoFs are those in the global and global equity income sectors, namely the Lazard and JPM trusts, the F&C Managed Portfolio Growth and trusts, London & St Lawrence, and British Empire.
Exceptional range
JP Morgan Elect Managed Growth has the best five-year NAV returns in this group. It differs from the others in that it is predominantly in-house, with at least 70% of its assets invested in JPM-managed vehicles.
However, this does not unduly inhibit manager Katy Thornycroft, as JP Morgan's exceptionally wide range of trusts covers most of the world's most important and interesting equity markets.
And a number of them - notably , and - have been performing well, yet trade on forgiving discounts.
The JPM trust's recent returns have been restrained by its 45% UK weightingWhen Thornycroft can't find enough choice or value among JPM's closed-ended funds, she can invest up to 30% in JPM open-ended vehicles, and she invariably has 20 to 30% in third-party funds.
The latter can include specialists in areas such as technology and trusts with exceptional managers such as , and Thornycroft says they have "definitely paid their way" in recent years.
The JPM trust's recent returns have been restrained by its 45% UK weighting (which is unlikely to be significantly reduced, as its benchmark is evenly split between the FTSE All-Share and the FTSE World indices) and by it being underweight in emerging markets, which has now been neutralised.
In addition, Thornycroft says a number of its formerly strong holdings were "challenged by the reversal we saw from growth and momentum factors in the market, and in some cases gearing played a part given the market sell-off". It will be interesting to watch how she repositions it.
Lazard World Trust has the second-best five-year NAV returns, and is hoping to enhance its appeal by committing to distribute 3.5% of its NAV at the start of each financial year.
The average discount on WTR's holdings has recently been in the mid-20sIt aims to provide "a broad exposure to equity markets though a diversified portfolio of closed-ended investment companies and holding companies, many on very wide discounts".
Its top 10 holdings include such familiar names as , and .
The average discount on its holdings has recently been in the mid-20s, offering plenty of scope for corporate activism.
Eclectic opportunities
Most of the other FoFs are in the flexible investment sector, and offer exposure to more eclectic investment opportunities such as hedge funds, private equity and credit.
is very defensively managed and has looked dull in strong markets, but has achieved its objective of steadily increasing its NAV per share.
offers very low-cost exposure to a selection of alternative investment funds, but with over 60% in hedge funds it has suffered as they have failed to sparkle.
The managers of have struggled to turn around the eclectic portfolio they inherited three years ago, but have done better this year, helped by a 16% exposure to emerging markets and the boost to overseas holdings from sterling's post-Brexit devaluation.
Sterling devaluation has also been a much-needed shot in the arm for and . HAST and the New Star trust are both on massive discounts, but neither has such an obvious catalyst for rerating as British Empire.
British Empire discount touches all-time high
British Empire's performance over the past 10 years has been dire. As a result its shares trade on a double-digit discount, despite buybacks.
However, performance has perked up since the market bottomed in February, and if this is not maintained there is likely to be agitation for change by US activist investor Elliott Associates, which recently acquired a 5% stake.
This is the same Elliott Associates that shook up the board at and is waiting to see whether ATST's managers need to be replaced.
Elliott's stake-building in British Empire is a case of the biter bit, in that a key part of the latter's mission over the years has been to take stakes in closed-ended funds and holding companies trading on wide discounts, and "encourage" them to take actions that will bring the share price much more closely into line with their NAV.
BTEM's manager says value has 'invariably reasserted its effectiveness' over the long termBTEM pursued this policy very successfully from 1985 to 2003 under John Walton, but lost its way under his successor John Pennink. Joe Bauernfreund, who worked alongside Pennink for several years, took over as manager in September 2015, and has made significant changes.
He has concentrated the portfolio into fewer holdings with stakes of 4 to 6% in those where he is most confident of a catalyst for change.
He has pushed harder for corporate action within his investee companies. And he has ensured that British Empire is not just fully invested but more recently 8% geared.
He hopes his efforts will be assisted by a return to favour of value as opposed to growth-oriented investing.
Bauernfreund says value has been out of favour for the past eight years, which is "the longest such period of underperformance since 1976", and over the long term it has invariably reasserted its effectiveness.
Another headwind is that pressure from other activist investors, plus increased competition from open-ended funds, has been forcing trusts and closed-ended companies to work harder to unlock value for investors.
Europe accounts for 38% of BTEM's regional exposure, which may not appeal to everyoneChanges are already under way at BTEM holdings such as , and .
Having risen to 33.4% following the Brexit vote, the average discount on British Empire's holdings barely contracted in July. This means it is close to its all-time peak, and the trust should benefit significantly as it reverts to more normal levels.
The discount on the trust's shares plus those on its holdings means investors are enjoying a discount on underlying value of over 40%.
Europe accounts for 38% of BTEM's regional exposure, which may not appeal to everyone, but a lot of it is in German residential property companies and Scandinavian family holding companies that have been working their assets well recently.
The Americas account for 28%, and Japan, Asia Pacific and emerging markets for around 11% each.
The UK accounts for only 7%, which was helpful after the Brexit vote, as currency gains on the rest of the portfolio offset the widening in the average discount. Bauernfreund needs to keep working effectively to keep Elliott Associates at bay.
This article was originally published by our sister magazine Money Observer here
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advise
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