Investment trusts are similar to unit trust and OEIC funds in many ways. They are all collective investment funds, where investors pool their money to invest in a wide range of assets. An expert fund manager manages these assets, and in turn receives a management fee. The main difference between them is that investment trusts are structured like ordinary companies. This means that they usually have a fixed number of shares in issue at any one time and can borrow money to make additional investments.
As investment trusts are traded like shares, their shares can trade at a premium or discount to the value of their assets. Demand and supply factors determine the value of the shares in investment trusts, and this usually means trusts that have been underperforming the sector usually trade at a discount to its net asset value (NAV). On the other hand, a strongly performing trust is likely to trade at a premium to its NAV.
Buying investment trusts that are trading at a discount to their NAV can be regarded as a bargain, as you are purchasing a collection of assets for less than the sum of its parts. But there is no guarantee that the discount will close and a sizeable discount could be regarded as a warning sign for poor management, excessive fees or lacklustre investment performances.
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We will now look at whether it would be wise to invest in these five heavily discounted investment trusts.
| Share price (p) | NAV (p) | premium/discount | |
| Alliance Trust plc | 495.3 | 567.4 | -12.7% |
| Mercantile Investment Trust plc | 1712.0 | 1928.5 | -11.2% |
| Templeton Emerging Markets plc | 455.7 | 519.4 | -12.3% |
| Caledonia Investments plc | 2341.0 | 2840.0 | -17.6% |
| Fidelity China Special Situations plc | 134.5 | 162.3 | -17.1% |
Alliance Trust (LSE: ATST), the globally-focused investment trust, has been trading at a discount of more than 5% for a number of years now. With an investment return of just 1.4% in the first half of 2015, its recent performance has been underperforming its peers.
But management seems to be finally getting their act together. It has engaged with an activist hedge fund Elliott Advisors to tackle its bloated cost structure and improve its performance by increasing its share of equity investments.
The trust could take action to shrink its discount, by buying back shares in itself on the open market to reduce the discount in its shares. It did just that in 2011, when it bought back some £350 million worth of its own shares. With pressure from an activist investor, a return to share buybacks is quite likely.
Mercantile Investment Trust (LSE: MRC) is a UK-focused equity investment trust that has a long history of outperforming the sector. In the past year alone, the investment trust delivered a 20.9% after fees return on its NAV, which compares favourably to the peer average of 17.0% and the FTSE All Share total return of 5.0%. With an ongoing annual charge of just 0.50%, its 11.2% discount seems unjustified.
Templeton Emerging Markets Investment Trust (LSE: TEM) is one of the most popular emerging market investment trusts on the market, with assets under management totalling £1.63 billion. Unfortunately, its heavy exposure to China and Brazil has meant its investment performance has lagged its peer average in recent years.
Caledonia Investments (LSE: CLDN) has a significant proportion of its assets in private unquoted companies through direct holdings and private equity funds. Because of its heavy exposures to the UK, the rest of Europe and Asia, its investment performance has lagged the sector average. On top of this, it has a very high ongoing annual management charge of 2.61%.
Fidelity China Special Situations (LSE: FCSS) trades at a very substantial discount to its NAV, as the recent volatility in the Chinese equity markets and sell-off in emerging markets has reduced demand for the trust. As volatility settles down in China’s equity markets, the trust’s discount could narrow to its historical average of around 10%.
More information?
The Association of Investment Companies (AIC) publishes a wide range of data about investment trusts, including the premium/discount that they trade at, the amount of gearing used and their ongoing charges. Click here to see its latest published statistics.
