The average investment trust traded at a double-digit discount of roughly 12% at the start of this year (Association of Investment Companies data), but investors who get too fixated on discounts may be missing out, according to the team at Peel Hunt.
Anthony Leatham, senior analyst at the firm, said: “I think sometimes we get a little caught up in the discount conversation.”
Certainly, there are scenarios where investors are right to focus on the discount to net asset value (NAV) for a trust, with his colleague Markuz Jaffe pointing to periods where trusts have outperformed market expectations.
However, the analysts argued emphasising discounts has several downsides. First, as investment trust discounts narrow, good value opportunities become less clear, according to Leatham.
See also: Investment trusts: Ain’t no discount wide enough
“The number of obvious anomalies in conventional equity trusts is now quite limited; they’re now mostly trading around where I would expect,” he told Portfolio Adviser earlier this year.
On top of this, it works far less well in specific sectors, particularly in alternative areas such as commodities, private markets or renewables, according to Jaffe.
Jaffe said: “Some investors may look at the renewable infrastructure space, for instance, and assume that because all are in the same sector, they all do the same thing.
“But when you unpack the portfolio, there can be a lot of moving parts and complexities, and if you’re not being paid enough for taking on that extra complexity, why bother?”
This emphasis on discounts may prevent investors from getting the “whole picture” of a trust and the opportunity cost of investing in it compared to other yielding assets, such as bonds.
“We want to move beyond the discount conversation and get into whether an investor is getting sufficiently compensated for the level of risk they have taken,” Leatham said.
To do this, the Peel Hunt team focuses on the share price IRR (Internal Rate of Return) to determine which trusts reward investors for the risks they take over the very long-term, compared to a low-risk asset such as bonds.
This is a particularly useful way to identify value in the infrastructure space, because managers in this area tend to value their assets using a similarly long-term approach, according to Jaffe.
For example, a solar farm might have an estimated life of 30 years, meaning investors are generally not very worried about contract renewals that occur over the next three years, he explained.
This is not how investors usually look at investment trusts, according to the Peel Hunt team.
“Investors may value their strategies on an IRR basis, but it only tends to be when there’s a catalyst such as a cash exit or wind up,” he argued.
“But that’s a small cohort; most are buying strategies with a five-year view.”
This means discounts or asset prices can easily be whipped around by short-term factors, such as discounts widening on a real estate trust because tenants failed to pay rent, which may temporarily decrease the value.
“IRR exposes the gap or disconnect between private markets, where assets are transacting and where public markets are valuing these portfolios.”
“It helps investors get a sense of if you buy the shares today, what’s your long-term return profile look like, the same calculation you might apply to buying a long-dated gilt.”
See also: Reigniting the relevance of investment trusts
Peel Hunt’s Jaffe pointed to INPP (International Public Partnerships), a popular infrastructure investment trust, as a good example of why investors should go beyond the discount.
When speaking to Portfolio Adviser earlier this year, the trust traded on a roughly 15% discount (which has since narrowed to about 11%). However, at the time, Peel Hunt had given the strategy an IRR of closer to 9.1%.
“If you think INPP is a quite low risk portfolio, due to the government counterparty risk and long-term contractual revenues, then it looks quite compelling.” This is particularly true when you compare it to other yielding assets such as bonds, he said.
The 30-year gilt now trades above 5%, following concerns over Prime Minister Keir Starmer’s position after a battering in the recent local elections. On INPP, investors are a handful of percentage points pick up on a low-risk asset, Jaffe explained.
See also: Gilt yields rise again as Starmer fights to stay in Downing Street and Iran crisis rolls on
“For this reason, INPP is one of our preferred picks.” He continued. “We like the portfolio, it’s performing as expected, it’s transacting assets that show its book value is representative, if not slightly conservative. What’s not to like?”
