Keep hunting for investment trust bargains

I have long been a fan of investment trusts, largely because these listed closed-end funds tend to outperform their more “conventional” unit trust peers.

The evidence for this alpha gap — the outperformance due to manager skill — came in a 2018 academic report from Cass Business School which found that the performance difference between investment trusts and a comparable unit trust averaged about 0.8 per cent per annum over any one year. 

It suggested that the structure of an investment trust, where managers don’t have to contend with constant inflows and outflows, may have led to better investment decisions.

That said, investment trusts have drawbacks, not least because a discount can open up between the underlying value of the assets (called the net asset value) and the share price. This discount can sometimes emerge for no good reason and can, in some circumstances, represent an opportunity for contrarian investors. Those gaps are especially valuable today, where bullish sentiment is rampant. 

Also, as the tax year ends, it’s worth considering trusts for your tax-efficient Isa investments.

According to data from the Association of Investment Companies, the trusts’ trade body, and Morningstar, the average discount across all listed funds is near a historic low at 3.39 per cent, down from 8 per cent a year ago. 

But there are still isolated opportunities lurking on the market’s fringes. I have trawled through data provided by fund analysts at Numis and Investec searching for funds which, I think, still represent decent value.

I looked for funds with evidence of above-average management skill, in spaces where there is still potential for upside. I then broke the short list of potential funds, with discounts above 10 per cent, into three groups.

The first were good, well-managed funds which happened to be in the wrong space at the wrong time. Next were those funds where the discount was partly self-inflicted because of a manager’s past actions, but where it seems managers have now got their act together.

The last category comprised a few funds where there didn’t seem to be any compelling reason for a big discount — they’d simply been left behind. 

With all these funds there’s an obvious rider — many big discounts are justified, and narrowing that discount will need some catalyst.

I therefore applied a further test: choosing funds where the current discount had been at least 10 per cent tighter in recent years. If the discount has closed once it could close again. 

My 15 picks are tabled below. Of course, some of the highest-scoring funds also arguably present the biggest risk. Take Georgia Capital, which invests in the small Caucasian economy, partly through listed investments such as Bank of Georgia, but increasingly via private equity holdings.

I think the fund is well managed, but I suspect it’s just too fringe for most investors. The same goes for Raven’s popular collection of state of the art logistics parks in . . . Russia.

Great business, but geography is a barrier. The Regional Real Estate Investment Trust (Reit) is less risky but we have to accept that commercial property is a tough sell at the moment. But the Schroders European Reit looks really cheap and has produced some impressive recent returns (I own shares in this fund).

I think Sherborne C shares are also a speculative bet. Its huge single stock holding in Barclays is not a risky proposition: you’re buying into a well-run UK bank at a 30 per cent discount to the share price. But what catalyst might turn this around? The constant discussions about strategy don’t seem to be quite working. 

Meanwhile, Empiric Student property is well positioned to benefit from the Covid recovery in student accommodation, but its record is variable. 

Other funds that stand out are Pershing Square, Middlefield, India Capital Growth, Oakley Capital, Strategic Equity Capital, JPMorgan Mid Cap and Aberdeen Standard Asian Focus.

Pershing Square is a hedge fund that is long on high-quality, consumer-focused US large-caps. Middlefield, which pays a useful 5.7 per cent yield, is a high-quality portfolio of North American mega caps. Both have unreasonably high discounts.

The India Capital growth fund has underperformed in recent years, but a change of approach (and manager) should help as Indian mid-caps potentially benefit from a global reflation trade. Oakley Capital is a private equity fund with a strong technology focus and a growing specialism in education technology companies.

JPMorgan mid-cap and Strategic Equity are plays on a UK rebound, the latter in larger small-cap firms under its new managers from Gresham House.

David Stevenson is an active private investor and has interests in securities where mentioned. He is launching a blog, futurefoodfinance.com, aimed at investors in the sector. Email: adventurous@ft.com. Twitter: @advinvestor