After a year of fierce discounts, which saw investment trusts drop to their most attractive valuations (as measured by the discount level) this century, the market for investment trusts looks to be stabilising. Since May/June the average discount has hovered around the 16% mark. That is huge and the likelihood of it narrowing significantly in the near term is not in the forecasts but at least it is not getting wider. Given the prevailing economic background, this is as good as it gets.
The reasons for the stubbornly wide discounts are many and include: the impact of interest rates on trusts investing in “alternative” assets, news rules around cost disclosure that are making some investment trusts less attractive to investors and fixed income assets which have increased in their relative attractiveness (government bonds with their gilt-edged guarantees are yielding between 4.5%-5% and investment grade corporate bonds are offering around 6.5%)1. But interest rates are now close to peaking and discounts are consequently holding steady.
Alternatives has been the sector that has seen the greatest drop in sentiment and widest discounts. Property is an obvious casualty but it has not been the worst hit. The Renewable Energy Infrastructure sector takes that unfortunate accolade. The combination of higher interest rates, a surge in traditional energy prices and the methodology of how underlying investments in the sector are valued, have all taken their toll.
Bargains in the fire sale
Every fire sale has its bargains or in the parlance of our industry, “some great investment opportunities”. UK equity trusts invested in small to mid-sized companies fall into that category in my estimation. With discounts in the region of 13%-14%, having underperformed for some time and with the underlying equities also trading cheaply, the longer-term potential is appealing.
Private equity is another interesting area. There are big discounts for some trusts while net asset values have not fallen. When sentiment pivots, the discounts have the potential for a sharp about turn. Another noteworthy development in this space is the announcement by Pantheon International of a share buy-back programme2. Since its announcement in August that it would repurchase £200m of its shares during this financial year, it has bought back approximately £7.35 million (as of 25 Sep), at prices ranging from 269.5p to 281.5p. The next step is a £150 million reverse auction at minimum share prices between 280p and 315p3. This is a good news story for Pantheon and for the sector.
Last call for orders
A sharp recovery in investment trust discounts in not imminent but there are good reasons to expect that 2024 will be a better year than 2023. A small risk of recession lingers but if that can be dispelled, on the first signs of rate cuts emerging on the horizon, even distantly, the resurgence could be rapid.
1 Bloomberg 12 September 2023
2 Citywire, 3 August 2023
3 AIC, 25 September 2023.
