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Tax, investments and pension rules can change over time so the information below may not be current. This article was correct at the time of publishing, however, it may no longer reflect our views on this topic. If you are unsure of how suitable an investment is for you, please seek personal advice from our award-winning Financial Advisers.

Investment trusts - how to spot value

| Investment Analyst | 5 October 2017 | A A A
Investment trusts - how to spot value

No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Whether it’s shopping in the sales or negotiating a cheaper price for a car, everyone likes a bargain.

But discounts aren’t just for clothes and vehicles. In fact some investments can also be bought for less than their intrinsic value.

Investment trusts are the prime example. To explain how, first we need to look at how investment trusts work.

Investment trusts differ from open-ended funds (unit trusts and OEICs) in that their share price is driven by supply and demand. If a trust is popular with investors and there are more buyers than sellers, its price can be driven higher than the value of the underlying investments (its net asset value, or NAV). This is known as trading at a premium.

On the other hand, if demand for an investment trust is weak and there are more sellers than buyers, the price can be driven lower than the NAV. This is known as trading at a discount.

For example, if a trust’s underlying assets are valued at £1 per share, but the share price is 90p, the trust is at a 10% discount to NAV. Investors are effectively buying £1 of assets for 90p.

Investment trust knowledge centre

The opportunity and the risks

Investment trusts can trade at wide discounts when they fall out of favour. If sentiment improves, these discounts can narrow, and even become premiums. Herein lies an opportunity.

If a trust is trading at a premium, investors are prepared to pay more to buy the shares than the underlying investments are worth. The risk here is that if the investment loses popularity, the premium can turn into a discount and investors lose money.

There are other considerations. A discount can arise following a poor period of performance, or because investors believe the trust has poor prospects. Similarly, premiums can arise when investors have high expectations for the underlying investments and believe paying a little more will be worth it over the long term.

It is not always the case that simply buying at a discount will result in stronger returns than buying at a premium. You also need to consider the track record of the fund manager, the prospects for the area in which they invest, and whether the trust meets your investment objectives and appetite for risk.

Investors could also look at how a discount or premium on one trust compares with similar trusts or those in the same sector. They should also be compared with history – a 5% discount might look attractive today, but if the trust traded on a 20% discount a year ago, the opportunity to benefit from a narrowing discount might have passed.

Investment trust managers have the flexibility to borrow money in order to purchase investments - this is referred to as 'gearing'. While gearing can magnify gains if the manager is correct, it also magnifies losses if he is wrong and is therefore a higher-risk strategy. Details of the charges and risks can be found in each trust’s annual reports and accounts.

Investment trust research

Five examples of investment trusts currently trading at a discount

The table below shows five of the most popular investment trusts with HL clients, which are trading on the largest discounts. Discounts and premiums for more than 400 investment trusts can be found in our investment trust section.

Investment Trust Current discount 12-month average
Henderson Smaller Companies -15.6% -15.2%
Aberdeen Asian Smaller Companies -15.6% -14.2%
Fidelity China Special Situations -13.0% -12.9%
JPMorgan Indian Investment Trust -11.3% -10.9%
BlackRock World Mining Trust -11.2% -12.3%

Source: HL, correct at 30/09/2017

Henderson Smaller Companies

Amid Brexit uncertainty and concerns over the prospects for the UK economy, sentiment towards the UK has wavered over the past year. This has affected investment trusts investing in small and medium-sized companies in the UK, which tend to be more domestically focused than their larger counterparts, and discounts have widened in some cases.

Over the longer term we feel smaller companies offer excellent capital growth potential, although they are higher risk. Neil Hermon, the Henderson Smaller Companies Trust’s manager, adopts a pragmatic investment approach of investing in companies that demonstrate consistent earnings growth and has built a strong long-term track record, although past performance is not a guide to future returns.

Henderson Smaller Companies share price, charts and research

Aberdeen Asian Smaller Companies

Asian smaller companies have underperformed larger business over the past year and the discount on the Aberdeen Asian Smaller Companies trust has widened. In our view, Asian markets represent good value and their smaller businesses offer exciting long-term growth potential, although this is a higher-risk region in which to invest.

We have long held Aberdeen's well-resourced Asian equities team in high regard for their meticulous research and disciplined investment approach and like their focus on high-quality companies, which they can purchase at sensible valuations. We believe this approach will serve investors well over the long term.

Aberdeen Asian Smaller Companies share price, charts and research

Fidelity China Special Situations

Investor sentiment towards China has fluctuated in recent years as fears over slowing economic growth have come and gone. The trust’s discount has generally continued to widen since its launch in 2010, although Dale Nicholls has delivered an attractive return for investors since assuming responsibility for the trust in January 2014. This is not a guide to how the trust will perform in future.

In our view, Chinese shares currently look good value and, combined with the Fidelity China Special Situations trust’s current discount, this could mark an attractive entry point for investors, although please remember investments will fall as well as rise in value.

Fidelity China Special Situations share price, charts and research

JPMorgan Indian Investment Trust

Interest in the Indian stock market has been revitalised since the appointment of Prime Minister Narendra Modi in 2014, and the subsequent implementation of significant economic and political reform. The discount on the JPMorgan Indian Investment Trust has remained relatively wide, however.

India is currently undergoing historic change and we are positive on its long-term investment potential. That said, the full effects will take time, which means a patient approach to this higher-risk market is essential.

JPMorgan Indian Investment Trust share price, charts and research

BlackRock World Mining Trust

The mining sector faced a challenging five years until 2016, but subsequently saw a dramatic turnaround in performance as mining companies have worked on reducing costs and debt, while increasing productivity. The BlackRock World Mining Trust continues to trade on a reasonable discount, however, and our analysis suggests the sector still looks good value.

That said, this remains a higher-risk, adventurous area in which to invest and the profits of these companies will remain closely tied to any fluctuation in commodity prices. In our view, the trust is managed by an experienced and well-resourced team, which has the potential to add value for investors over the long term.

BlackRock World Mining Trust share price, charts and research

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The information in this article is not intended to be advice or a recommendation to buy, sell or hold any investment mentioned, nor is it a research recommendation. No view is given as to the present or future value or price of any investment, and investors should form their own view in relation to any proposed investment.