Discount recovery a 'buying opportunity' for bargain listed trusts

Investment trusts have been trading at a discount, but the gap between the underlying value of their assets and share price could be closing, which could mean now may be a good time to buy shares and invest.  

Trusts have broadly traded at a discount this year, where the underlying net value of the assets in a trust is worth more than the implied valuation of its share price. Discounts have been exacerbated by a growing dislocation between high private valuations and weakness in stocks. 

Anthony Leatham, research analyst for investment companies at stockbroker Peel Hunt, said trust discounts have mirrored market sentiment, and that rather than suppressed share prices being a concern, this could be a boon for investors. 

“Given where sentiment is and given the amount of listed market volatility and style rotation that investors have experienced, it is understandable that discounts across private equity trusts have widened and this is consistent with other bear market periods,” he told Proactive. 

“However, for the long-term investor, the statistically-significant discount levels that we see today should provide an attractive entry point. Additionally, if the macro headwinds were to abate, then we would expect to see discounts narrow.” 

Opportunity

Where there is discount caused by macro events, as has happened many times previously, a recent analysis by the Association of Investment Companies (AIC) showed an uplift in those trusts’ share price in the proceeding years, indicating the potential for shareholder gain. 

According to the AIC’s analysis, the average investment trust returned 31% in the three years after the Brexit vote in 2016, led by the technology and media sector.

“If you look back at history when discounts have been at this level in the past and look at performance in the years following; historically, the returns have tended to be very strong,” said Richard Hickman, managing director at HarbourVest (LSE:HVPE) Global Private Equity Limited. “The discounts in previous times have tended to narrow.” 

Investment trusts hold investments in a range of investee companies and invest in funds that buy equity in privately held companies. 

This can mean that if the valuations of their privately held assets exceed the market capitalisation or implied valuation of their share price, they effectively trade at a discount.  

“There is a disconnect between the share prices that private equity investment trusts are trading on and the value of their underlying portfolios (net asset value or 'NAV'),” explained Leatham, who added that in his view the underlying valuations are not inflated. 

Underlying value

A widening gap between average private valuations and relatively suppressed share prices has been caused by high interest rates and a “capital flight” from the UK market, rather than being endemic, according to investment managers. 

Hickman said there have been UK-specific factors including an ongoing withdrawal of capital, or a “capital flight”, from the UK in recent years as international investors have fled the market, which has had a knock-on impact on exchange-traded funds (ETFs).  

Trust managers say the valuations of the assets in their portfolios simply haven’t had the dramatic peaks and troughs of public markets, that the managers of those assets have been conservative with valuations, and that there is a lag between NAV and share price.  

“They didn't value all the way up with public markets in 2021 and so the portfolio valuations had less distance to fall,” Alan Gauld, senior investments director and lead portfolio manager at Abrdn PLC (LSE:ABDN)'s Private Equity Opportunities (APEO) investment trust, told Proactive. 

He said high exit, or sale, prices demonstrate the sensible valuations on offer in Abrdn’s portfolio, “evidenced by the average 25% valuation uplift upon exit”.

“Our long-term track record on exit uplifts has not been materially impacted by any market downturn as yet.”  

Recovery

If share prices across the market are suppressed due to transient macroeconomic factors, with a recovery in view, then it could offer a relatively cheap way to get hold of assets with a greater underlying net value.  

Constantin Gurdgiev, associate professor of Finance at the University of Northern Colorado, told Proactive: “General markets rebound in the first quarter of 2023 has driven both listed and private funds recovery.” 

According to analysts, there are some early signs that investment trust discounts could now be narrowing in the UK small-cap and midmarket. Investment broker Stifel said in a research note earlier this month that “there has been some narrowing of discounts on the UK mid and small-cap specialists in recent days”.

Broker analysts said the discount narrowing “may reflect share prices holding up reasonably well at a time when NAVs have fallen sharply over the past month”.  

For example, Schroders PLC (LSE:SDR)'s UK midcap-focused trust Schroder UK MidCap had experienced a “sharp narrowing” of its discount to 8%, the narrowest it had been for the past six months. 

That narrowing of discounts on some UK small-cap and midmarket investment trusts, according to Stifel data, suggests some could soon once again reach par, where the underlying value of privately held assets matches the implied value of a stock listing.  

Gauld predicts that the gap between NAV and the share price of listed investment trusts will continue to close.  

“The discount has only been as wide as it is now during the Global Financial Crisis and the beginning of the Global Pandemic,” he told Proactive. “The annualised NAV Total Return of APEO since 2001 is 11.3% and we see strong growth going forward, especially as direct co-investment increases as a proportion of the portfolio. Therefore, we view the current discount as a buying opportunity for investors that are willing to take a longer term view.”