That’s how Chair Juliet Davenport described full year: “This has been a transformational year for the Company. We have assembled a highly diversified solar portfolio, offering one of the most secure income profiles in the UK listed renewables sector. We are now the partner of choice for some of the largest blue-chip corporations in the UK to help them deliver on their net zero targets. This has been a driving force behind our significant pipeline. We are delighted that our origination and installation strategy has continued to bear fruit, delivering significant valuation upside for shareholders.” As for the numbers: “…we have committed more than £149 million into clean energy solar assets generating an additional 120MW of solar PV capacity and increasing our GAV today to £215 million…Overall NAV per share declined 0.8 pence, driven by a 7.7 pence per share decrease as result of increasing the valuation discount rate to 7.4% from 6.6% (March 2023: 6.2%) as well as dividends paid of 5.0 pence per share…”
In terms of outlook: “…the renewables sector continues to benefit from strong tailwinds, namely energy security and net zero targets both at the corporate and government levels. The Company is experiencing very strong demand and has a strong potential pipeline of value-accretive opportunities totalling £410m. The Company now has a best-in-class reputation for delivering flexible solar solutions, evidenced both by the increasing number of new customer enquiries and feedback from its existing customers…It is our ambition to grow the Company…and in the short term the Company has access to a £20 million accordion which will be used to fund near-term commitments and pipeline. The Investment Adviser is monitoring opportunities to recycle capital from operational assets into installation assets which provide greater opportunities for capital growth. The Company is also working with its advisers to identify potential strategic investors who could provide capital to the Company through a variety of different structures.”
Winterflood notes: “NAV per share -0.9% to 92.0p. Key drivers were: (i) £15m gain from installation assets signing PPAs or reaching energisation (operational assets increased over the year from 62MW to 147MW) (+10.0p); (ii) adjustments for new contract pricing (+3.0p); (iii) net cash generated minus fund costs (+0.6p); more than offset by (iv) increase in unlevered discount rate from 6.6% to 7.4% (-7.7p); (v) reduction in inflation forecasts (-0.9p); (vi) lower power price forecasts (-0.9p); and (vii) dividend paid (-5.0p)…Electricity generation was 36.3GWh over the year, +0.7% above budget…”
Liberum is a buyer: “ROOF made some good portfolio strides in the FY and post-period, growing to become the UK’s largest commercial and industrial solar platform. The long-duration contracted cash flow model is an ongoing differentiator, with c.80% of revenues contracted over 10-years, which is c.25 percentage points ahead of peers and this effect leads to ROOF’s relatively low sensitivity to power prices (-4.6% NAV impact from a 10% decline in power prices). 92% of income is subject to annual inflation or fixed uplifts, with 47% benefitting from uncapped RPI or CPI uplifts. 79% of the portfolio is fully operational and 21% is in the installation phase, with full energisation expected by Q1 2024. In addition to increasing the distributions received base, this should provide a catalyst for NAV uplifts. We are BUYers with a 100p TP on ROOF’s shares.”
“Overall, we enter the new year with the mindset that we are continuing to travel towards the danger, rather than away from it, and we will not let a disappointing 2023 obscure what we see in front of us.” RICA monthly investment report for December 2023 during which NAV/share price rose 2.1%/4.2% respectively.
To optimise shareholder value
abrdn Diversified Income & Growth (ADIG)
Annual Report from abrdn Diversified Income & Growth (ADIG) . Chair Davina Walter had this to say: “…our Investment Manager has continued to pursue its strategy of seeking to provide income and capital appreciation over the long term from a genuinely diversified portfolio, providing access to a wide selection of asset classes, an attractive and dependable level of income and defensive characteristics relative to the volatility of equity markets. Despite the Board’s confidence in the investment strategy, the persistent and entrenched discount to Net Asset Value…led the Directors to commence a strategic review in June 2023 to consider how the Company could best restore and deliver value to shareholders.” And as the Chair explains: “In the light of the feedback received and the persistent discount to net asset value…at which the Company’s shares continued to trade, the Board concluded that it was in the best interests of shareholders as a whole to put forward proposals for a managed wind-down of the Company.”
As for how the fund performed over the year, the investment managers reported: “…a total NAV return of 0.4% with 3.6% volatility, a good risk adjusted return per unit of risk taken. This compared with a 13.2% return in equities as measured by the FTSE All-Share Index with 11.6% volatility, and -0.6% in government bonds as measured by the ICE BofA UK Gilt Index with a volatility of 11.5.” Back to the Chair for the outlook: “Global markets continue to be volatile, and, whilst there are some positive signs of recovery as inflation abates, the medium-term outlook for UK equity markets remains subdued, especially in terms of the investment trust sector. This is likely to continue to weigh on ADIG’s valuation relative to NAV, hence the proposals we are putting forward for an orderly Managed Wind Down which seeks to optimise shareholder value.”
Comment from Winterflood: “Under the managed wind-down announced in December 2023 (subject to shareholder approval at 27 February AGM), the Board expects that £115m will be returned to shareholders in H1 2024 at, or close to, NAV. Further returns of cash will follow as value is realised from the private markets portfolio (58.4% of 30 September NAV). c.£107.3m (valuation as at 30 November 2023) of private holdings expected to mature by 2027. Remaining £81.5m expected to mature between 2029 and 3033, and opportunistic secondary sales would be considered. The fund will cease to make new investments but will fund existing commitments. Outstanding debt (£16.1m of secured bonds with 6.25% coupon maturing in 2031) will be repaid in 2024.”
Challenge of the week
“The challenge for central bankers from here is to thread the needle of holding rates high enough to keep inflationary pressures at bay and bring inflation back to target while at the same time, not tipping economies into recession. The US appears to be treading this path well, while data in the UK and Europe is suggestive of a more imminent downturn.” abrdn Diversified Income & Growth (ADIG) Investment Manager’s Report.
Tip Watch #2: Keep faith in my 2023 investment trust tips – they WILL come good
So says This is Money’s Jeff Prestridge. The commentator opens his above-titled article by highlighting how in 2023 “…equity investing…proved very much hit and miss…” Why? Because of “…a mish mash of factors – from uncertainty over the global economy to continued geopolitical tensions and a toxic mix of persistent inflation and high interest rates.” What’s more “The performance of investment trusts reflects this uncertain backdrop…of the 380 stock market-listed funds covered by the industry’s trade body, the Association of Investment Companies, only 210 (55 per cent) have generated positive returns during 2023 – returns including both dividends and capital gains, but excluding investor costs. Factor those in and the number of positive returners reduces further…Of course, when five-year performance numbers are looked at, the picture changes. Far more funds (three quarters of them) have delivered positive returns.”
As for Prestridge’s 2023 tips: “This time last year, I assembled an investment trust portfolio that I thought could deliver spectacular returns. Not necessarily straightaway, but certainly over three to five years. The portfolio comprised ten trusts…investing in different parts of the world, some for growth, others for a mix of capital and income return…What linked these ten trusts a year ago was the fact that their share prices did not reflect the value of their underlying assets. They were sitting at big double-digit price discounts…My thesis was that these bargain prices would not last forever –resulting at some stage in a performance boost. I thought that maybe the discount propellant might kick in this year.” The ten trusts are listed below:
abrdn New India; Augmentum Fintech; Herald; Seraphim Space; Aberforth Smaller Cos.; Brunner; Invesco Asia; Schroder UK Mid Cap; Templeton Emerging Markets; and VinaCapital Vietnam Opportunity
The article continues: “So what’s happened to these trusts over the year? Have they delivered the stellar returns I thought they were capable of? The answer is no. I know this because I invested £100 in each of these ten trusts at the start of the year via my stocks and shares Isa. Looking at my Isa yesterday, the collective value of these holdings was £845.32. Add in the dividend income I have received of £15.09, and my £1,000 investment is now worth £860.41. In percentage terms, that is a significant fall of 14 per cent.” Despite the disappointing performance, Prestridge is sticking to his guns: “…I still believe that this portfolio will prove itself in time. Tellingly…nine of these trusts still have share prices at a big discount to the value of their underlying assets. These discounts will disappear if market sentiment improves. Maybe that will happen next year, maybe not. But I will hold these ten trusts until they sparkle.”
Funds on the Watch List this week include: SMT, SLFR, CRS, DNA2, TENT, SSIT, PSH, PHI, APEO, CVCG, HHI, BRFI, FSV, SCP, ANII, AUGM, HRI, ASL, BUT, IAT, TEM, VOF, BPCR, MCT, JGGI, AIE Welcome to this week’s Watch List where you’ll find golden nuggets on trust discounts, dividends, tips and lots more…
By Frank Buhagiar 08 Jan, 2024
BARGAIN BASEMENT Discount Watch:
Our estimate of the number of investment companies whose discounts hit 12-month highs over the course of the week ended Friday 05 January 2024 – the same total as the previous week.
No change in the overall number maybe, but all change at the individual trust level. This week’s trio: Third Point Investors (TPOU) from hedge funds; CQS Natural Resources Growth & Income (CYN) from commodities and natural resources; and JPEL Private Equity (JPEL) from private equity.
ON THE MOVE Monthly Mover Watch: two new names
Muscle their way onto Winterflood’s list of top-five monthly movers in the investment company space. Triple Point Energy Transition (TENT) takes fourth spot courtesy of a 23.2% gain on the month. Shares have reacted well to the mid-December announcement: Proposed Orderly Realisation of Assets. Seraphim Space (SSIT), the other newbie occupies fifth place with a 22% share price gain. Not much in the way of news over the past month from SSIT, but the space investor was mentioned in despatches by This is Money’s Jeff Prestridge – see below Media City section.
As for the three funds retaining their places in the top five, these include the seemingly permanent fixture that is SLF Realisation Fund (SLFR), although the monthly gain did shrink to +25% from +36% – a sign perhaps that the tailwind from November’s news of a return of capital to shareholders is on the wane?
No sign of that happening with Crystal Amber (CRS) which is also in return of capital mode via buybacks – shares are up 26.6% compared to last week’s 24.2%; or Doric Nimrod Air Two (DNA2) which recently completed a “Partial Compulsory Redemption of Shares”.
Scottish Mortgage Watch: +4.2%
Scottish Mortgage’s (SMT) monthly share price gain as at Friday 05 January 2024. That’s a sharp reduction on last week’s +12.2%. Similar story in terms of NAV – up 1.6% on the month compared to 4.8% previously; and the wider global IT sector, a +6.8% gain shrunk to +3.9%.
THE CORPORATE BOX Buyback Watch: BioPharma Credit (BPCR)
Announced buybacks are back on the agenda after issuing an update on its LumiraDx (LMDX) loan. Over to broker Jefferies for a quick summary: “This announcement marks a successful recovery of BPCR’s troubled loan to LMDX. The business being sold to Roche represents 81.5% of the total loan amount outstanding, but 117% of BPCR’s current carrying value for its 50% share of the loan, so implying a small c.2% NAV uplift. We also note there could be a further recovery of value for BPCR and the other senior lenders upon liquidation of the company. Importantly, BPCR is likely to be able to resume share buybacks now it is no longer an insider, with the recent EGM circular highlighting $115m of cash available for repurchases (equivalent to c.9% of NAV), aimed at closing the discount into 5%. All together this points to some healthy upside to the current share price, with the shares currently trading on a 16% discount to NAV, not least because the recovery firmly validates the manager’s process and the strength of security in protecting the principal value of the loan.”
Issue of Equity Watch #1: £1,787,840
The value of shares issued by Ashoka India Equity (AIE) on 2 January 2024. In all, the Company “…issued 740,000 of its ordinary shares of one penny each (Ordinary Shares) pursuant to its block listing facility. The Ordinary Shares will be issued at a price of 241.60 pence per Ordinary Share, a premium to the prevailing net asset value (cum income) per Ordinary Share.”
Issue of Equity Watch #2: £501,000
The amount raised by JPMorgan Global Growth & Income (JGGI) following the issue of “…a further 100,000 Ordinary Shares for cash at 501 pence per share under its Ordinary Share block listing facility.”
Dividend Watch: 5.3p
The amount per share Middlefield Canadian Income Trust (MCT) proposes to pay out in dividends during 2024, an increase on the 5.2p paid out in 2023: “…the board of directors has declared an increase in the quarterly dividend to 1.325 pence per Share…This increase follows the increase to 1.30 pence (from 1.275 pence) announced in January 2023. In 2023, the Fund paid four quarterly dividends totalling 5.2 pence per share (2022: 5.1 pence per share). During 2024, the Fund intends to pay four quarterly dividends each of 1.325 pence per share, in January, April, July and October…”
MEDIA CITY
Tip Watch #1: Investment Ideas of the Year 2024
Courtesy of The Investors’ Chronicle. First a quick reminder that, when it comes to recommendations, the tipster changed tack a few years ago: “…we changed our focus from a series of individual shares to five portfolios of 10 stocks that capture what we think are some of the most interesting opportunities for stockpickers. This year, our biggest tweak has been to reduce the size of those portfolios, which now contain five ideas each.” And one of those five portfolios is comprised entirely of…investment trusts.
The Chronicle acknowledges that it’s been a tough time for London’s investment companies: “For the past couple of years, despite facing record discounts to net asset value (NAV), the resounding response from the market has been to shrug and look elsewhere. Although there have been some signs of repair in recent weeks as interest rate expectations have adjusted, the average investment trust’s share price was trading 15 per cent below NAV as of early November, according to Winterflood…” And as the article adds, “…investors should treat discounts the way regular equity investors treat valuations. Just as earnings ultimately drive stock prices, what should matter most to trust holders is underlying growth in NAV. Fortunately, there are some excellent investment trusts out there doing just that, including the five…below.”
Pershing Square (PSH)
Pacific Horizon (PHI)
abrdn Private Equity Opportunities (APEO)
CVC Income & Growth (CVCG)
Henderson High Income (HHI)
Turns out, the above are not the only trusts included in the five portfolios. In the Global Portfolio, there is room for BlackRock Frontiers (BRFI) which is “…still trading at a discount despite a recent rally – looks a smart way to get exposure to nations with strong fundamentals for the year ahead, and with an income kicker.”
Elsewhere, Fidelity Special Values (FSV) is included in the Small Cap Portfolio. As the article explains “…travel deep enough into the lower reaches of the market, and you’ll start to find what would normally look like pricing anomalies.” And that includes investment trusts: “Why…should we make space for…Fidelity Special Values (FSV) investment trust as well as individual companies? For the simple fact that FSV – like so many other well-run trusts – has its own discount.”
Finally, Schroder UK Mid Cap (SCP) finds itself in the Special Situations Portfolio because it “…looks vulnerable to M&A activity given its relatively small size and the presence of activist investor Saba Capital on its shareholder register.”
I’d follow Warren Buffett to start building a massive passive income stream
When it comes to earning money without working for it, Warren Buffett certainly knows a thing or two.
In fact, it was Buffett who said that, “if you don’t find a way to make money while you sleep, you will work until you die”.
That may sound dramatic.
By taking a few leaves from his book, I reckon I could potentially build massive passive income streams.
Look where the ball is going
Warren Buffett is a smart enough investor to know that a company’s current performance is not enough to justify an investment.
Instead, he looks at whether he thinks a company has what it takes to do brilliantly in the future – and whether that is reflected in its share price.
So the current dividend yield of a share is not necessarily an indication of what sort of passive income it might generate in future.
Instead, Warren Buffett looks at what sort of business advantages it enjoys and how its finances look. From that he can decide whether he likes the future income generation potential of a business. That in turn influences its ability to pay a dividend.
That has led Buffett to own Dividend Aristocrats like Coca-Cola and American Express, that have raised their dividend annually for decades since he purchased them.
The power of compounding
In fact, in his most recent letter to shareholders of his firm Berkshire Hathaway, Buffett pointed out that he spent $1.4bn on Coca-Cola shares back in the 1980s and 1990s. That holding now generates over $700m of dividends every year.
In other words, Buffett is getting half his original investment back every year as passive income – and still owns the shares, which incidentally have soared in value.
That shows the benefit of finding the right companies to invest in.
But it demonstrates another thing that has been critical to Buffett’s fortune-building.
What does Warren Buffett do with all those dividends? He uses them to make more investments that in turn will hopefully also generate large returns.
Aiming high
That is known as compounding.
When it comes to passive income, it can be tempting to start taking dividends as income immediately.
For example, imagine I invest £300 each month in shares yielding an average 8%. If I take the dividends out as cash, after 25 years I would be earning £7,200 annually.
But if instead I invested the same amount and compounded the dividends, after 25 years my portfolio would be able to generate almost £22,000 in passive income generally, if I decided to start receiving the dividends as cash.
Warren Buffett often emphasises the power of simplicity. I think building large passive income streams can indeed be simple. But it will not happen unless I take the right steps to make it happen!
LWDB continues to set itself apart from peers in the sector by utilising its unique structure…
Overview
Law Debenture (LWDB) is a very differentiated proposition, and is unlike other investment trusts in the sector, largely down to its unique structure. It owns a portfolio of UK equities, managed by James Henderson and Laura Foll, and also operates as a leading provider of independent professional services (IPS). This structure allows the managers running the investment portfolio to better balance the requirement for immediate income with the potential for capital growth, given the IPS business funds over a third of the trust’s total dividends, owing to its steady and repeated revenues ). The IPS business continues to generate strong and growing revenues, the growth rate being 11.2% in the first half of 2023.
The combination of the investment portfolio and IPS business has led to a strong track record of outperformance against the sector and FTSE All-Share Index, over one, five and ten-year periods. James and Laura think the UK market offers incredible value currently. In their eyes, a wide pool of opportunities has opened to own cash generative businesses that are well-managed, resilient and positioned to deliver strong returns over the long-term. With UK equities sitting at historically low valuations, including close to a three-decade low against global equities, they believe there is no shortage of market leading, high-quality, and undervalued companies to exploit, so have added investments they feel hold the potential to re-rate quickly when sentiment returns and markets rally, including Rolls-Royce.
At the time of writing, LWDB’s historical yield is 3.8%. While lower than some peers, the board has a record of maintaining or increasing the dividend for shareholders over the last 44 years.
Analyst’s View
We believe that LWDB is a good way for investors to generate dividends from the UK market in a less conventional way compared to peers. Its unique structure, a blend of an investment portfolio and independent professional services (IPS) business, means it has more flexibility to attack different parts of the market typically avoided by other income portfolios. The nature of IPS’s businesses make , a level of contribution that we think is key to the overall LWDB strategy. Not having to focus purely on a strong income, the managers running the investment portfolio can pursue a more diverse range of opportunities including companies that boast lower yields, but greater return potential. In our view, this flexibility is invaluable in the current market environment, and something that’s also contributed to strong dividend growth and outperformance over time .
IPS has demonstrated defensiveness in times of market stress or throughout recessions, which we view as another strong benefit to LWDB. That said, we would argue that given some changes to IPS’s underlying businesses more recently, the mix has become less defensive and more cyclical. Being more exposed to global economic factors and having more cyclicality risk than in the past, could mean, in our opinion, revenues are slightly less defensive in periods of prolonged market stress or recessions. All in all, though, we think the IPS business continues to have good anticyclical businesses and dovetails nicely with the investment portfolio, providing good access for investors looking for well-diversified exposure to the UK.
Bull
The IPS business significantly underpins both the growth in capital and dividend
Demonstrates a long-term track record of outperformance against the sector and index
Very low OCF of 0.49%
Bear
Having a larger allocation to small and medium sized companies could hurt performance if economic conditions deteriorate
Offers a lower yield than many peers, although its dividend is growing
This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.
We think 2024 is starting with a new sense of optimism in the air, as the prospect of easing macroeconomic conditions is on the horizon. Last year was a difficult one for many investors, at least until the fourth-quarter rally. Rising interest rates created incentives to shift into cash, and this led to a significant widening of discounts on investment trusts. However, markets performed strongly at the end of the year. With expectations rising for rate cuts sooner rather than later, and any recessionary forces looking weak, the picture for financial assets is arguably brighter than it was last January.
Here we look at how investors responded to the uncertainty enveloping markets in 2023 by analysing the evolution of asset flows. We set out to see how open-ended fund flows compared to discount moves in the closed-ended universe, and where the sector stands. We think the analysis highlights some potential opportunities in cheap sectors.
Open-ended fund flows
Investment Association (IA) data on fund flows is only available up to the end of October. This is actually a pretty useful period to look at, as in the last couple of months of 2023 markets rebounded quite significantly. Up until this point, the data paints a bleak picture for the majority of IA sectors with retail and institutional investors redeeming £37bn over this time. As the table below shows, the UK All Companies and Europe (ex. UK) sectors experienced the most significant outflows over the period in absolute terms, with outflows of £9.2bn and £2bn respectively. This equated to 6.5% and 3.5% of funds under management (FUM) in the sectors at the start of 2023. As a percentage of FUM, the worst-hit sectors were healthcare and financials and financial innovation. Very few sectors saw net inflows, notably the global and global equity income sectors.
TOTAL SECTOR FUND FLOWS
IA SECTOR
TOTAL ASSET FLOW JAN 23 – OCT 23 (£M)
TOTAL FUM OCT 23 (£BN)
% CHANGE FROM START OF 2023
UK All Companies
-9,179
131.7
-6.5
Europe excluding UK
-1,966
55
-3.5
UK Equity Income
-1,889
33.6
-5.3
UK Smaller Companies
-878
9.2
-8.7
Healthcare
-763
24.6
-2.9
Specialist (equity)
-735
24.6
-2.9
North America
-618
81.7
-0.8
Financials and Financial Innovation
-383
2.3
-14.3
Global Emerging Markets
-336
32.2
-1.0
European Smaller Companies
-210
1.7
-11.0
China/Greater China
-178
2
-8.2
European including UK
-45
2.7
-1.6
Asia Pacific including Japan
-42
0.8
-5.0
Japanese Smaller Companies
-40
–
–
Latin America
-28
0.3
-8.5
North American Smaller Companies
-5
4
-0.1
Technology and Technology Innovation
25
7.1
0.4
Asia Pacific excluding Japan
124
32.2
0.4
India/Indian Subcontinent
152
4.2
3.8
Japan
271
21.8
1.3
Global Equity Income
774
22.2
3.6
Global
814
163.2
0.5
Unclassified Sector
1,406
–
–
Source: Investment Association, Kepler calculations, as of 31/10/2023
We think much of this likely came from the UK sectors, all of which experienced significant outflows from retail investors. A lot of this we would attribute to the sharp rise in interest rates used to combat inflation. High rates on virtually risk-free cash and short-term bonds were tempting, particularly as fears of a significant recession persisted through the year. However, negativity about the UK’s prospects was pretty extreme throughout the year, and we think many investors will have looked to the global sectors instead. Although it is reflected in the outflows of the UK All Companies sector the impact has been felt hardest in the UK Smaller Companies sector, with assets down over 8%. We would argue that funds have been caught up in this trade with little regard for the strength of their portfolios. The extent to which the UK has been out of favour is shown through total outflows which didn’t show any sign of easing through the course of the year—a total of £11.9bn. To put this into perspective, the second greatest outflows came from European equities which if we include smaller companies experienced just over £2.2bn of outflows.
European equities faced another challenging year with higher energy prices and supply chain constraints adding to a tough macroeconomic backdrop. The sector experienced the worst outflows in over a year during September and October 2023. As with the UK, the smaller companies sector was hit hardest with outflows equating to 11% of FUM at the start of the year. Overall, it has been unsurprising that investors moved away from more volatile assets with greater interest rate sensitivity, such as equities and property into more secure fixed income and money market products offering higher yield than medium- or long-term bonds (upwards of 5% risk-free), as highlighted in the table below. Alternative investments also suffered as a consequence of rising interest rates and rising costs of debt. This has been true, particularly for commercial property, which has continued to suffer from the persistent impact of hybrid working.
ASSET CLASS FLOWS
ASSET CLASS
TOTAL ASSET FLOW JAN 23 – OCT 23 (£M)
Mixed Asset (excl. Flexible Investment and unallocated)
-4,219
Equity
-3,678
Flexible Investment
-1,422
Property
-460
Others
220
Money Markets
1,107
Fixed Income
4,537
Source:Investment Association, Kepler calculations, as of 31/10/2023
Global Emerging Markets experienced strong inflows in the first half of the year. However, this reverted to outflows in the second half of the year. We believe this reflects investors looking to play a China reopening which disappointed, and then selling when the story changed. China faces a number of headwinds: regulatory uncertainties and the potential threats of government interventions along with elevated levels of geopolitical tensions are issues. Combined with the impact of de-globalisation and reshoring of manufacturing and the continued focus on sustainability this is having a negative impact on sentiment. The opposite is true with India. Since March 2023, the sector has experienced month-on-month inflows as investors look to the country’s growth story, driven digital transformation, the proactive approach taken by the government, its deep domestic capital market, and the ever-growing middle class.
Discounts
The picture of outflows at the top level is mirrored in widening discounts in the investment trust space. After 2022 which saw discounts widen from 2.2% to 11.8%, by 30/10/2023 they had moved out further to 17.3%—the widest level since the global financial crisis. We believe this may have presented a great opportunity for long-term investors—particularly in the hardest-hit sectors.
At the sector level, there were some similar patterns to the asset flows of their open-ended equivalents. The UK All Companies and UK Smaller Companies sectors saw their discounts widen from 10.2% to c. 14% as of October 2023. This has come despite many trusts delivering positive NAV returns. This includes ASL,THRG andJMI which have delivered a return of 8.2%, 6.8%, and 7.5% respectively compared to 0.4% generated by the FTSE All-Share over 2023. In addition, China-focussed strategies discounts have also widened from 9.5% to c. 14% during the year—wider than that seen by global emerging markets trusts which will have a less concentrated allocation to China.
The significant outflows from interest rate sensitive, debt-heavy sectors such as property, have been replicated in the widening of discounts across the closed-ended infrastructure and renewable energy infrastructure sectors over the year. In a similar vein to smaller companies, we believe there are opportunities for investors that can identify higher-quality investment opportunities within these sectors including3IN)andPantheon Infrastructure (PINT) which have delivered NAV returns of 11.6% and 9.9% over the year but are trading at discounts of 9.4% and 20.5% respectively. This is in addition to renewable energy infrastructure strategies such as UKWwhich is trading on a 10% discount and offers a high dividend yield linked to UK RPI.
However, some strategies have bucked the trend. For example, the global equity income sector has reflected the stability in terms of open-ended asset flows with its more stable discount, thanks to trusts such as IVPG,and JGGI. However, the UK equity income sector has also managed to maintain a relatively stable discount averaging 3.6% despite experiencing the third worst sector outflows over the year. We believe this reflects the higher demand for income strategies that provide higher dividends with revenue reserves providing longer-term security, alongside capital growth which can be boosted by gearing.
We also note that the open-ended India sector saw consistent inflows of assets over 2023, however, the closed-ended sector has only seen the discount come in to 11.1% compared to 13.5% at the start of the year. Only one trust currently trades at a premium in the sector AIE. The larger trusts in the sector have seen disappointing performance in recent years, which we believe has weighed on the discount. However, this provides an opportunity, particularly if active performance turns around. Indeed, Nick Greenwood, manager of MIGO and now part of the Asset Value Investors stable, flags JIIas interesting in this regard. There is a new management team in charge, and tender offers are on the horizon. Finally, whilst there were inflows into open-ended tech funds in the second half of 2023, the discount of the AIC technology and technology innovation sector has remained stubbornly wide, at 10%. Given the long-term structural supports for the tech sector, we think this is a striking opportunity to gain exposure to some of the world’s most innovative companies through trusts such as ATT
ONE-YEAR DISCOUNTS
Source: Morningstar
As mentioned above, October 2023 marked a turning point in markets where slowing inflation has led to a broad-based rally with the S&P 500 generating a return of 12.2%, and bonds represented by the iShares Government/Credit Bond ETF generating 7.9% as of 31/12/2023. This included a recovery in some more interest rate sensitive growth areas of the market. Even though Fed chair, Jerome Powell, said the central bank was “not thinking about rate cuts right now”, investors have shown some signs of cautious optimism. November Fund flows data from Calastone showed that a less uncertain market environment prompted a cautious return to inflows for some sectors adding back around 10% of the £4.54bn in outflows seen across a six-month period of net selling. This included flows into emerging markets, North America, and global mandates, whilst a sustained decline in bond yields saw an increased flow of capital into fixed income. That said, investors remain cautious and money market funds saw double the inflows to fixed income in November. In addition, infrastructure, Asia Pacific, Europe, and the UK continued to see outflows, albeit at a less severe pace.
This is also reflected in the quick narrowing of discounts of certain sectors, narrowing the average of the universe to 14.8%. This has been particularly evident in the interest rate sensitive areas of the market such as infrastructure sectors and the commercial, logistics, and healthcare property sectors which have effectively halved their discounts from c. 30% to 18%—we also note that logistics and healthcare traded at a premium pre-Q2 2022. Similarly, the discounts in the private equity sector (excl. 3i) have also narrowed since then to 28.6% versus 40% at the end of March 2023. In addition, there has been a slight narrowing of the UK and North American smaller companies sectors however, they still trade on a 10% and 9% discount respectively.
Conclusion
Investors have taken 2023 as an opportunity to re-evaluate their investment portfolios and take money out of riskier areas of the market as higher rates of return have been offered by a more diverse range of assets. However, we think the fact that the discounts across some of these sectors are beginning to narrow, may reflect the beginning of a shift in investor sentiment. Interestingly, this initial move has come from sectors yet to see inflows recover. We think this may suggest we could be coming out of a period of overdone selling pressure, which over the near term may provide an opportune entry point for investors to gain a powerful addition to returns through NAV upside and the narrowing of discounted investment trusts. When veteran trust of trust portfolio managers Nick Greenwood, MIGO, and Peter Hewitt, CT Managed Growth have both noted that the level of investment trust discounts may present a ‘once-in-a-generation opportunity’, who are we to argue with that?
