All I want is an investment trust on a juicy discount…

Investment trust discounts, under the right circumstances, could provide investors with significant return potential…

Josef Licsauer

Updated 18 Dec 2024

Disclaimer

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.

Picture a bustling British high street during a Boxing Day sale. Shoppers eagerly queue for bargains, drawn by the irresistible allure of a good deal. It’s quintessentially British to love a discount—whether it’s a half-price Greggs sausage roll or the Black Friday sale frenzy borrowed from the US. This passion for bargains extends beyond the aisles and into the world of investing. Here, discounts on investment trusts evoke a similar thrill: the opportunity to buy £100 of assets for £80. Who could resist?

But, as with any sale, not all bargains are created equal. Discounted trusts can offer significant upside if their share prices recover, but they also can signal significant risks. This raises a question: has investing in the most discounted trusts over the years been an effective strategy for delivering meaningful returns? In pursuit of this answer, we dove headfirst into the bottomless well of data, beginning with a broad analysis of how discounts in the investment trust universe behave during market cycles, before looking at those trading on the very widest discounts.

Extreme discounts

For some investors, discounts represent a compelling opportunity to capture additional upside, but they can also reflect market sentiment, management quality, and sector challenges, introducing another potential layer of risk for investors. At extreme levels, we believe that the widest discounts often carry a warning to investors, signalling a need for caution rather than opportunity.

A deep analysis of historical data reinforces this point. Our analysis shows that trusts trading at the steepest discounts, mostly those over 50% have invariably delivered negative share price returns in subsequent one- and three-year periods. These extreme discounts may stem from significant underlying issues, such as management struggles, sector-specific headwinds, or the obsolescence of an investment focus. The result tends to be persistent poor performance, making a strategy of chasing the deepest discounts a hazardous proposition. Blindly pursuing these perceived bargains can lead to bitter disappointment and we show the results of buying trusts on the widest discounts with a pure dartboard approach in the table below. It is not happy reading!

Widest discounts compared to one and three-year performance

YearTrust with the widest discount at the start of the yearDiscount (%)One-year cumulative return (%)Three-year cumulative return (%)
2005Tiger Royalties and Investments-35.830.952.3
2006Athelney Trust-23.423.9-38.6
2007Seed Innovations-89.840.9-57.8
2008Seed Innovations-91.8-31.0-88.1
2009Eurocastle Investment-97.2-93.1-95.2
2010Tiger Royalties and Investments-72.9-9.2-52.9
2011DCI Advisors Limited-77.1-19.5-54.8
2012DCI Advisors Limited-85.3-35.5-44.3
2013Livermore Investments-62.6-3.03.9
2014DCI Advisors Limited-52.9-0.9-71.8
2015DCI Advisors Limited-67.2-42.5-75.4
2016GRIT Investment Trust-82.4-11.3-86.5
2017Alternative Liquidity Fund-76.9-40.0-51.2
2018DCI Advisors Limited-62.1-15.8-21.1
2019Alternative Liquidity Fund-54.4-3.3-44.5
2020DCI Advisors Limited-75.0-6.3-25.0
2021DCI Advisors Limited-77.7-26.7-13.3
2022Tetragon Financial-69.61.0N/A
2023Seed Innovations-70.0-12.4N/A

Source: Morningstar. N/A – unavailable given the rolling three-year return data range.

Past performance is not a reliable indicator of future results

One can only apologise for the volume of data below, but to help provide further context, we’ve also plotted the average one- and three-year rolling returns of the 20 widest discounted trusts each year against the FTSE All-Share. Whilst this isn’t the fairest of comparisons for performance in all cases, we think it is a useful benchmark for the investor looking for bargains in the UK market to consider. Whilst there were years where the trusts outperformed, such periods accounted for only 36.8% of one-year periods and 21.1% of three-year periods, between 2005 and 2023. This helps reinforce our analysis that buying trusts with extremely wide discounts is a high-risk strategy. Deep discounts often signal structural or irreparable issues, and should serve as a warning to investors to tread very carefully.

So, where does this leave investors wanting to take advantage of discounts? A sensible starting point, in our view, is avoiding the deepest discounted trusts and instead focussing on trusts trading at more moderate discounts, supported by positive tailwinds and a higher quality portfolio. These may still trade at wider discounts than their historical averages but could present a better balance of risk and reward.

To test this theory, we revisited the data, this time excluding trusts trading at discounts wider than 40%. The results were telling. In every year except 2005 and 2006—when no trusts traded wider than a 40% discount—average one- and three-year returns improved significantly. By plotting the data in the same way as before, we found that these trusts (the 20 widest, excluding those above 40%) outperformed the FTSE All-Share on 57.9% of occasions over one year and 36.8% over three years. This is a substantial improvement over the performance of the very widest discounts above, but still underlines the point that just picking wide discounts won’t necessarily lead you to a good result.

Discount comparison (excluding 40%+)

YearWidest discount (%)Avg discount (over 20 widest trusts %)Avg one-year TR (%)Avg three-year TR (%)
2005-35.8-21.127.667.9
2006-23.4-15.520.7-14.5
2007-34.1-16.01.2-15.8
2008-37.7-28.7-24.2-19.2
2009-37.1-28.946.675.4
2010-39.4-31.617.030.7
2011-39.7-29.13.012.6
2012-39.7-33.31.429.1
2013-39.9-29.09.020.0
2014-36.2-30.36.733.3
2015-39.9-30.0-0.430.3
2016-37.8-30.223.539.6
2017-39.0-31.411.214.0
2018-39.9-28.3-6.31.2
2019-37.9-27.711.151.4
2020-38.3-30.67.51.3
2021-39.5-34.418.721.2
2022-39.7-32.4-4.7N/A
2023-39.5-35.33.3N/A

Source: Morningstar. N/A – unavailable given the rolling three-year return data range.

Past performance is not a reliable indicator of future results

Investing in discounted trusts always comes with a risk, even those at relatively moderate discounts, that they may persist for years. Discounts can also widen further, driven by factors such as weak relative performance, illiquid shareholder registers, or even sector-specific pessimism. However, we think the key is avoiding trusts hampered by structural challenges, as these will likely erode future returns or those with poor corporate governance.

This is why we believe it’s important for investors to focus on trusts that are supported by an array of strong fundamentals, like experienced management and a well-resourced investment team that can add an edge when it comes to stock selection, or trusts benefitting from favourable sector trends. My colleague recently advocated a similar case for trusts in the alternative income sector.He argues that there is a risk of falling into ‘value traps’. He concludes that the focus should be on quality trusts, that have been unfairly derated alongside their lower-quality peers, and focussing on those that exhibit resilience rather than being swayed purely by the allure of a wide discount.

Many factors can play a role in narrowing the discount meaningfully over time, or even shifting a trust to a premium rating. In the right environment, we think that patient, long-term investors that incorporate the analysis of discounts into their investment decisions, rather than being solely guided by them, could unlock compelling return potential.

Opportunities in today’s market

History may not repeat, but it often rhymes, much like stock market cycles. After enduring a series of seismic events over the past few years, including Brexit, the pandemic, a reversal in globalisation, conflicts in Europe and the Middle East, surging inflation, and political instability, we believe certain sectors, and indeed the trusts aligned with them, now offer compelling opportunities for investors.

One particularly interesting area is technology. Semiconductor stocks, and semiconductor-related stocks, fuelled by soaring demand from artificial intelligence (AI), have performed exceptionally well over the last couple of years, which has, in turn, rendered the sector seemingly expensive. Investment trusts like Allianz Technology Trust (ATT) have benefitted significantly from the AI surge, driving performance across its portfolio, and delivering a NAV total return of 40.0% over the past 12 months. Yet, or perhaps because of this, ATT currently trades at a discount of around 10.0%, wider than its average over five years of 7.1% and the sector’s average of 8.0%. As such, it offers investors exposure to market-leading tech giants, such as NVIDIA and Microsoft, at a 10% discount to their market value. Beyond the titans, ATT also provides exposure to differentiated large- and mid-cap stocks with significant growth potential, further diversifying its return profile.

We believe this valuation gap represents a clear opportunity to tap into one of the most dynamic sectors in global markets. We see potential in ATT’s double-digit discount narrowing, potentially delivering an extra uplift to investor returns as it does.

Looking through a slightly different lens, Fidelity Emerging Markets Limited (FEML) presents a potentially compelling opportunity for investors seeking both emerging market and tech exposure. The trust’s managers have built up strategic positions in Taiwanese and South Korean stocks over time, particularly those heavily integrated into the global technology supply chain and enablers of AI. Familiar names like TSMC and Samsung stand out as obvious beneficiaries, given their dominant market positions and global reach. However, the managers have also identified opportunities in lesser-known companies, such as SK Hynix, a leader in semiconductor memory, and their new 2024 portfolio addition, Elite Material. The latter, a Taiwanese manufacturer of copper-clad laminate—an essential input for printed circuit boards—is well-positioned to benefit from surging AI-related demand.

Similarly to ATT, FEML has performed well over the past 12 months, delivering NAV total returns of 20.1%, ahead of its benchmark, yet trades at a discount of 13%, wider than both its five-year average and the sector. With exposure to multiple growth trends within emerging markets, we see the potential for FEML’s discount to narrow, rewarding patient investors over time, although we expect there to be plenty of uncertainty in the short term, depending on the outcome of US tariff decisions.

Beyond technology, private equity discounts look potentially interesting. Below, we’ve highlighted average discounts from a selection of key players in the space, comparing them to the wider sector average. Notably, three out of the five trusts trade at discounts wider than the sector, and their own ten-year average, presenting a potential opportunity in our eyes. Broadly speaking, the market derated in 2020, causing discounts to widen dramatically. This impacted investment trusts, especially those like private equity trusts, which tend to be less liquid and harder to sell during market selloffs. Since 2022, discounts have largely been narrowing, though, and looking ahead to 2025, we believe some of the headwinds that have weighed on private markets are beginning to ease, creating a potentially attractive entry point at current discount levels.

Private equity discounts

Private equity trustsCurrent discount (%)Five-year average (%)Ten-year average (%)
HVPE-38.6-33.5-26.6
PIN-30.7-31.8-25.4
CTPE-29.3-27.3-19.1
NBPE-23.6-28.4-24.7
HGT-0.3-7.9-8.8
Morningstar Investment Trust Private Equity ex 3i-24.1-24.9-20.9

Source: Morningstar

Past performance is not a reliable indicator of future results

The most immediate catalyst for discounts narrowing is, in our view, an improvement in realisation activity. An improvement in dealmaking and exit conditions has been anticipated for much of 2024, driven by recovering macroeconomic conditions and a more favourable interest rate environment. So far, significant realisation activity has yet to materialise. HarbourVest recently commented that they are seeing a narrowing of the valuation gap between buyers and sellers in private equity, which they believe will lead to a “further pick-up in deal activity in 2025”.

In our view, these dynamics point to the potential for narrowing discounts on private equity trusts, alongside improved investor confidence. HG Capital Trust (HGT) which has a five-year average discount to NAV of 7.9% shows that a persistently wide discount to NAV is not necessarily guaranteed. HGT has benefitted from being in the technology space and delivering outstanding long-term NAV returns. Some trusts in the sector, particularly Pantheon International (PIN), have taken decisive action on buybacks and setting formulaic capital allocation policies. PIN’s discount has narrowed as a result, although there clearly needs to be a balance struck between buybacks and balance sheet strength in the face of the potential for realisation activity to remain muted. Trusts like CT Private Equity (CTPE), which offers exposure to a diversified portfolio of ‘lower mid-market’ private equity-backed companies, and HarbourVest Global Private Equity (HVPE), with a portfolio encompassing over 1,000 businesses ranging from hyper-growth startups to stable, cash-generative companies, both trade on discounts significantly wider than their ten-year averages. If sentiment returns to the sector, we think these trusts in particular could see their discounts tighten.

Outside of market trends and economic tailwinds, some investment trusts may see a narrowing of the discount thanks, in part, to decisive board actions. In recent years, investment trust boards have become increasingly proactive, not only by buying back shares to manage discount volatility but also by implementing strategic measures aimed at narrowing discounts more meaningfully. A prime example is Schroder Japan (SJG), which invests primarily in listed Japanese equities. Despite outperforming its benchmark over the past 12 months, the trust continues to trade at a discount wider than its five-year average, prompting the board to act.

To enhance its appeal with investors, differentiate it from peers in the Japan sector, and position the trust as a strong option for income-seekers looking beyond their traditional income-hunting grounds, the board unveiled an enhanced dividend policy aimed at paying out 4% of the average NAV each financial year. Additionally, it announced a performance-conditional tender offer: if the trust fails to at least match its benchmark performance over the five-year period starting 31/07/2024, the board will propose a 25% tender offer, allowing shareholders to exit a portion of their investment at NAV, less costs.

Since the announcement, SJG’s discount has narrowed. We think these measures not only show conviction in the abilities of manager Masaki Taketsume, but also provide a clear incentive to continue delivering alpha, and at the same time, have broadened the trust’s appeal as an alternative income option. This, together with providing investors access to the exciting developments ongoing in Japan, leads us to think there is potential for its discount to narrow further.

Conclusion

Discounts in investment trusts present both opportunities and challenges. Whilst the allure of trusts trading at the absolute widest discounts may tempt investors, the historical data underscores the dangers of chasing these seemingly deep bargains. Discounts often reflect more than undervaluation; they can signal genuine structural or sector-specific challenges that hinder recovery.

Additionally, our analysis of 20 years of market data, examining rolling three-month returns from three major indices—the FTSE All-Share, MSCI Europe ex UK, and the S&P 500—alongside the discount movements of investment trusts revealed a striking pattern. During periods of sharp volatility—such as the 2008/09 financial crisis, Brexit, or the coronavirus pandemic—investment trust discounts widened significantly. However, unlike equity markets, which often rebounded within 12 months, average discounts across the sector frequently took years to recover. We think this lag, particularly pronounced in sectors like property, private equity, and infrastructure, reflects the slower adjustment of private asset valuations and heightened investor risk aversion during turbulent times.

Rolling returns versus discount movements

Source: Morningstar

Past performance is not a reliable indicator of future results

Whilst investing in a discounted trust may lead to strong returns over time, investors will have to get comfortable with the fact it may take more time to bounce back, despite strong performance from equity markets. Moreover, some trusts may face structural barriers that actually prevent their discounts from narrowing, potentially eroding returns over time. As such, focussing on quality trusts with moderate discounts, supported by positive tailwinds, may yield stronger results, in our view. By understanding the reasons behind a discount and the factors that might support its narrowing—such as portfolio quality, strong management, or exposure to structural growth trends—investors who look beyond the headline figures and incorporate discount analysis into broader investment decisions, rather than being solely guided by them, could unlock significant returns, often unavailable in open-ended funds.

A long-term perspective is essential. By examining the drivers behind a trust’s discount, identifying catalysts for potential narrowing, and ensuring alignment with personal investment goals, investors can better navigate the sales racks of the investment trust world. The rewards lie not in impulsive decisions but in uncovering opportunities that can stand the test of ti