Asia Pacific among worst-hit sectors as discounts widen
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The average discount at which investment trusts trade to their assets have widened in recent weeks amid tumbling stockmarkets.
Asia Pacific excluding Japan, Global Emerging Markets and Latin America top the list of regional all-cap trust sectors that suffered the most. Some average sector discounts widened by nearly five percentage points in a few trading days.
Among those that saw the biggest volatility in its discounts was Anthony Bolton’s Fidelity China Special Situations trust, which temporarily moved to its widest ever discount of 9.2%. It bounced back and has been slightly better than the sector average since, but it is still nowhere near last year’s highest premium of nearly 20%.
Market falls and subsequent sell-offs started earlier this month and were exacerbated by the Standard & Poor’s downgrade of America’s sovereign debt to AA+, as well as rumours of other downgrades.
Although investment trust shares had lagged market falls at the time of writing, most saw their discounts widen nevertheless.
In particular, those trusts that invest in less liquid assets, such as hedge funds and private equity, suffered. Some experts compare the market falls with the experience of 2008, when discounts widened to significant levels after the collapse of Lehman Brothers.
Simon Elliott, the head of research at Winterflood Investment Trusts, says it is likely that discounts will widen further, but unlikely that they will reach such extreme levels again.
Iain Scouller, an analyst at Oriel Securities, says the widening trend is in line with what would be expected during a significant market fall. “However, there has been quite a mixed performance in discount trends between the different geographic sectors,” he adds.
Global emerging markets, Asia Pacific excluding Japan and Latin America have seen their discounts widen most, according to Oriel.
Some trusts have reduced their leverage significantly to take account of market falls. Leverage exacerbates losses when stocks fall as it increases a trust’s gross exposure to the market, usually above the standard 100%. In turn, this magnifies its performance. It is therefore typically only increased, or maintained for that matter, when the manager of the trust is bullish on their investments.
Bolton’s trust has reduced its gross exposure from 125% of net asset value in June to 114%.
Gerald Smith, the manager of Baillie Gifford’s Monks investment trust, has reduced its gross exposure from 108% to 92%.
Other investment trust managers have also reduced gearing, suggesting they have generally become less confident about their investment universe.
Meanwhile, British specialists have seen their discounts narrowing or premiums increasing. Global Growth & Income, UK Growth and UK Growth & Income were among the strongest performers. UK High Income has been the most strongly performing sector, moving from a discount of 4.8% to a premium of 3.4% in less than three weeks.
Neil Woodford’s Edinburgh investment trust, for example, received a “sell” rating from Numis Securities because it was trading at a stubbornly high premium. Charles Cade, the head of investment companies research at Numis, has also said that other UK Growth & Income funds in general look expensive.
While he regards Woodford highly, Cade says the high premium has made the trust less compelling. In his latest update on the sector, he recommends that investors switch into the equivalent open-ended fund or a different investment trust.
Other investment trusts can help to control their discounts and reduce the volatility of their share prices by buying back their own shares and cancelling them. While this can bolster the value of the trust’s assets per share, it results in higher costs.
Scouller and his team have not observed a significant increase in investment trusts buying back their own shares. “Anecdotal evidence suggest that many investment trust holders have adopted a wait-and-see approach,” he says.
“Looking further afield towards Asia and emerging markets, those who had been underweight these higher growth regions’ markets and were waiting for a more attractive entry point may now wish to consider adding to their exposure.”
After all, falling markets create opportunities for investors who wish to buy out-of-favour asset classes on discounts. Elliott says this has led to “significant outperformance” when markets eventually turned and discounts tightened.
Aiming to identify investment opportunities, the research team at Winterflood has analysed the performance of investment trusts over the past couple of weeks.
Despite market falls, Elliott says there is not as much value in the investment trust sector as one might expect.
Yet he adds that there are indeed “some pockets of value” presenting interesting opportunities for investors prepared to be contrarian and take a long-term view.
Even though temporarily wide discounts represent an incentive to buy investment trusts cheaply, experts warn against impulsive purchases and urge investors to adopt a long-term strategy.
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