Compass - December 2020
With the average investment company up 8%, Ian Cowie celebrating his winners and managers optimistic about 2021, we're in good spirits as we hang up our st
By Annabel Brodie-Smith
No-one will forget 2020 in a hurry. The pandemic has ruled the year, impacted all our lives and sadly has been devastating for many people. Brexit is continuing to be a cliffhanger but deal or no deal it’s finally coming to some sort of conclusion. Despite this, there’s still plenty of good news for investment company investors which may contribute some much-needed festive cheer as 2020 draws to a close.
The investment company industry has risen to the challenges of the coronavirus crisis with its dividend advantages and suitability to invest in less liquid assets coming to the fore. The average investment company has returned 8% in 2020 to the end of November despite the breath-taking twists and turns of markets this year and the industry’s assets have recently reached a record high of £221bn. Both considerable achievements in a tough year.
Hedge Funds were the top-performing investment company sector of the year in the 11 months to November up 56%. The sector performed remarkably well with volatile markets being helpful to many of their strategies. And recently, Pershing Square Holdings, an investment company from that sector, was promoted to the FTSE 100. Less surprisingly, considering technology has been a lifeline this year, Technology & Media achieved the second-highest return of 42%. This was followed by the Global sector with 36%, Japanese Smaller Companies with 32% and Japan with 28%, reflecting strong rebounds from the pandemic lows.
The key question is what happens next? Where do fund managers think the future opportunities lie? On Tuesday I had the pleasure of talking online to Job Curtis, manager of City of London, Charles Plowden, manager of Monks and Simon Barnard, co-manager of Smithson Investment Trust. Do watch our conversation as it’s a fascinating insight into how these managers have positioned their portfolios post-COVID, where they think they may find the future winners and most importantly why. From healthcare and supermarkets to internet subscription services, travel and mining companies, the managers have their eagle eye on a diverse range of opportunities.
Investment company managers share their views on the past year and give an outlook for 2021
Talking of what happens next, our annual fund manager poll on predictions for 2021 and beyond is always a must-read. Of course, the pandemic’s dominance of 2020 demonstrates that no-one can predict what will happen in the future. As ever, investors need to focus on creating a balanced long-term portfolio which meets their needs but all the same it’s useful to read managers’ views. With a vaccination program underway, investment company managers are optimistic about the threat of COVID diminishing, and over two-thirds believe markets are set to rise next year. Healthcare is tipped to perform best in 2021 but the much longed-for return to normal is influencing managers’ thinking over five years, with travel and leisure predicted to be the top sector. I do hope they are right – the prospect of a holiday abroad makes me feel positively giddy with excitement!
Ian Cowie, our investment expert, takes a look back at the winners and losers in his portfolio last year. He has some positive returns to celebrate with his “Big Three” winners and good news from his new income investment companies, JPMorgan Japan Smaller Companies and Ecofin Global Utilities & Infrastructure. However, as ever, it doesn’t all go to plan and it’s great Ian is so frank as I always love hearing about the ones that got away…
Finally, Faith Glasgow has a really helpful article on buying investment companies that trade on a persistent premium and what you need to consider before doing so. It’s a very relevant topic with 88 investment companies, nearly a quarter of the industry, currently trading at a premium to the value of their assets.
As ever there is way too much to do at this time of the year... It’s going to be a busy weekend. I need to buy and decorate the tree, write my cards and track down the most enormous Nerf gun for my 10-year-old son.
I’m sure it will be a different Christmas for many of us this year but I do hope you have a jolly and fun time and also get an opportunity to relax. I’m so ready for the relaxing part!
Wishing you a Merry Christmas and a Happier New Year.
Communications Director, AIC
Results from our investment company manager survey are in.
Investment company managers have tipped Emerging Markets to outperform in 2021, according to the annual poll conducted by the AIC. The poll was carried out with AIC member investment company managers between 9 and 30 November 20201.
Despite many developing economies having been hit hard by the pandemic, 24% of managers feel Emerging Markets are most likely to reward investors next year, followed by the UK (19%) and the US (14%).
Managers are bullish on Emerging Markets and the UK over the longer term too. On a five-year view Emerging Markets and Asia Pacific excluding Japan were seen as the most attractive opportunities, each receiving 19% of the votes, with the UK and US tied in second place with 14% of responses each.
Reasons to be cheerful
With vaccines soon to be rolled out across the globe, the threat of COVID-19 receding is deemed the greatest cause for optimism by managers next year, gaining 38% of the votes. However, managers are also optimistic about the possibility of technology driving economic growth, with this and a value-growth rotation each receiving 14% of responses.
Interest rates rising is seen as the biggest threat next year (19%) followed by high equity valuations (14%).
Despite the economic fallout from the pandemic, 90% of managers believe UK interest rates will not turn negative in 2021 and 71% feel it is either ‘unlikely’ or ‘very unlikely’ that we will see a significant increase in inflation.2 However, on a three-year view 77% of managers believe a significant increase in inflation is either likely or very likely.3
Best-performing sectors in 2021
Almost a fifth (19%) of managers believe Healthcare Equipment & Services will be the best-performing equity market sector in 2021. On a five-year view, managers favoured Travel & Leisure companies to outperform, with 19% nominating the sector to recover strongly from a catastrophic 2020.
Investment company managers are optimistic about the prospects for global stock markets, with 67% believing they will rise in 2021 and only 10% believing they will fall. Nearly two-fifths of managers (38%) feel the FTSE 100 will close between 6,500 and 7,000 next year. A third (33%) were more optimistic about the UK’s blue-chip index, with 7,500-8,000 (19%) and 7,000-7,500 (14%) the next most popular choices.
In a year where the pandemic impacted everyone’s lives, 62% of managers reported that their investors’ interest in ESG had increased due to COVID-19.
Annabel Brodie-Smith, Communications Director of the AIC, said: “With a vaccine on the way, investment company managers are optimistic about the threat of COVID diminishing, and over two-thirds of them believe markets are set to rise next year. The prospect of a much longed-for return to normal is influencing managers’ thinking, with healthcare tipped to perform best in 2021 and the travel and leisure sector predicted to be the top sector over five years. Investors’ interest in ESG strategies has been sharpened by the pandemic. Over both the short and long term Emerging Markets are favoured by managers but despite a difficult year and a persistent cloud of Brexit uncertainty, the UK is seen as attractive for the future.
“Of course, it’s interesting to look at managers’ views but the pandemic’s dominance in 2020 demonstrates that no-one can predict what will happen in the future. Investors need to focus on creating a balanced long-term portfolio which meets their needs.”
Manager comments on 2021 and beyond
Andrew Bell, Chief Executive Officer of Witan Investment Trust, said: “The future looks very positive, with revolutions in information technology and medical science transforming lives for the better. Investment in infrastructure will help drive recovery from 2020’s economic shocks. Asian consumption, technology and biotechnology remain key long-term themes. Near-term, banks and the travel and leisure sectors are likely to bounce strongly as investors make a rational analysis of their prospects rather than extrapolating the awful short-term trends from 2020.”
Dean Orrico, Portfolio Manager of Middlefield Canadian Income, said: “While the fight against COVID-19 is far from over, the availability of vaccines, together with improving treatment protocols and therapeutics, are important steps towards a gradual improvement in employment and consumer confidence, thereby contributing to a recovering economy as we head into 2021. A more constructive economic backdrop, we believe, should drive equities higher over the next 12 months, with a significant contribution from more value-oriented sectors including REITs and financials.”
Zehrid Osmani, Portfolio Manager of Martin Currie Global Portfolio Trust, said: “We are constructive on global equities for 2021 and beyond, given our view that interest rates will remain low for prolonged periods of time, with supportive monetary and fiscal policies and the low yields environment pushing investors to consider equities’ earnings yield as more attractive versus bonds. Long-term valuations currently point to European and Asian equities looking attractive relative to US equities.”
Charles Plowden, Manager of the Monks Investment Trust, said: “We look to the future with the same approach which has served us well through this pandemic. This is a rigorously bottom-up process, focusing on individual companies which are addressing significant growth opportunities with ambition and adaptability. We are living through a time of unprecedented technological advance across multiple industries; this is enabling new competitors to disrupt the established order with better and often cheaper solutions. If the incumbents do not respond radically and rapidly, they are destined to decline. We expect markets to further polarise, as they have in 2020, between the future winners and the rest. Any company’s willingness and ability to respond to current pressing environmental and societal pressures is yet another test of its resilience and even its survivability. Where this leaves overall markets and sectors in the short term is anyone’s guess: I prefer to leave such prognostications to others.”
Steve Cook, Portfolio Manager of Sequoia Economic Infrastructure Income Fund (SEQI), said: “There is no denying that 2020 has been a challenging year for us all, with widespread economic uncertainty hitting the markets. Looking ahead to next year, although there are still many unknowns, one thing we can be sure about is an increased focus on ESG. The COVID-19 crisis has accelerated the shift towards sustainability, with businesses across the country calling for a green recovery, and these issues will no doubt be at the top of investors’ priorities. At SEQI, we are looking forward to continuing to implement our ESG policy and playing whatever part we can in enabling the transition to a lower carbon world.”
Simon Barnard, Portfolio Manager of Smithson Investment Trust, said: “Our approach to ESG has not changed. We assess all potential investments for sustainability at the very initial stages of our research process. We also continue to engage with executive management and supervisory boards of our investee companies to promote what we believe to be best practice in the areas of corporate governance and management remuneration. Our investment company focuses on buying, and holding for the long term, shares in high quality listed companies that will compound in value over time. These companies have proven to be extremely resilient during the pandemic and the strong performance of the trust is a testament to this.”
Alasdair McKinnon, Manager of the Scottish Investment Trust, said: “Gold has been one of the standout assets of the pandemic and we believe that it can thrive in the coming environment. Some view gold as a safe haven, though we see it as a sort of currency – one that cannot be devalued by the colossal monetary and fiscal measures we are seeing now. Many investors have become accustomed to low inflation, but ‘money printing’ is ultimately inflationary and we believe that markets are underestimating the potential for a prolonged bout of above-average inflation. Gold miners ought to prosper in those conditions.”
Richard Staveley, Fund Manager of Gresham House Strategic, said: “The rejection of UK equities and value shares in favour of US equities and growth shares which has dominated investor behaviour in 2020 is likely to recede in 2021. Disparity in popularity will remain, but vaccine developments should enable an ongoing reduction in extreme market positioning despite a likely resurgence in Brexit-related headlines which are probably already priced in.”
UK becoming ‘investible’ again
Simon Gergel, Portfolio Manager of the Merchants Trust, said: “In 2021, the UK will have exited the EU. The end of uncertainty is likely to lead to the UK becoming ‘investible’ again after 4.5 years in the wilderness. Like we saw after the promising Pfizer COVID vaccine trial results, the end of uncertainty over Brexit is likely to lead to fundamental reassessment of UK equities, which are some of the cheapest amongst the major world markets. Within the market, value shares and domestic cyclicals look particularly interesting.”
Jean Roche, Co-Manager of Schroder UK Mid Cap Fund, said: “The most notable development as 2020 draws to a close is a spike in incoming M&A activity in the UK, indicating that UK assets have become too inexpensive to be ignored. We can expect this to continue as the Brexit clouds clear and markets gain confidence in the distribution of a COVID vaccine. What will also be interesting to see is whether, long term, behaviour around distribution of earnings as dividends moderates. We could see management teams seeking to increase investment to grow companies, a behaviour which, well executed, will drive sustainable growth and earnings, as well as more resilient dividend streams.”
Alex Wright, Portfolio Manager of Fidelity Special Values, said: “From a macro and geopolitical perspective, many uncertainties remain from the outcome of Brexit negotiations to the timing of the withdrawal of support measures and likely future tax increases. While a no-deal Brexit scenario would clearly be a negative outcome, the robustness of UK supply chains through the COVID-19 crisis does give us some comfort that companies are better prepared than previously thought. Deal or no deal, the end of negotiations should lift some of the uncertainty that has plagued UK equities for the past five years.”
Job Curtis, Fund Manager of the City of London Investment Trust, said: “The combination of monetary and fiscal stimulus and the roll out of effective vaccines are positive for global economic growth. After underperformance compared with the average of world stock markets, the UK has the capacity to surprise to the upside. In general, stocks with above average dividend yield with growth should be well supported given continuing low interest rates.”
Asia and emerging markets
Robin Parbrook, Co-Portfolio Manager of the Schroder Asian Total Return Investment Company, said: “Whilst we are personally feeling a little more upbeat about life, when it comes to potential returns from Asia’s stock markets we are less optimistic. With Asian indices up 50-60% from March lows valuations are now high and are clearly anticipating a sharp turnaround in corporate earnings. Tell-tale warning signs are also flashing amber whether it is bubble like valuations in the electric vehicle, biotech and internet sectors, the heavy issuance of IPOs of increasingly dubious quality or high levels of retail investor participation. All this leaves your fund managers cautious. We still believe we can make money in 2021 but investors must temper their expectations and tread carefully.”
Chetan Sehgal, Lead Portfolio Manager of Templeton Emerging Markets Investment Trust, said: “Over the longer term, COVID-19 should be a bump in the road for China’s long-term growth, given it has been rebounding quickly from it. The healthcare sector is also an area we’re watching closely. We’ve seen the Chinese government cultivate an environment where healthcare innovation is rewarded. This will likely improve the prospect of affordable healthcare in China. We see immense opportunities for China going forward.”
Ramesh Mantri, Adviser to the Ashoka India Equity Investment Trust, said: “Indian equity markets have continued their upward trend through Q3, and this should instil confidence for investors looking to access the region into 2021. India remains a powerhouse for IT services, and this sector continues to gain market share as businesses around the world accelerate efforts towards cloud migration, digital adoption, and modernization of technology infrastructure.”
Emily Fletcher, Co-Manager of BlackRock Frontiers, said: “Without the ability to extend as much support to their citizens as Western economies, we expect developing economies to emerge from the crisis without the excessive debt burden of many Western economies and at the same time displaying higher growth levels. Although hit hard by the global lock downs, frontier economies have displayed a remarkable resilience, helped by the flexibility of their labour forces.”
Nicholas Price, Portfolio Manager of Fidelity Japan Trust, said: “A number of themes present themselves. Certainly, clean energy and environmental efficiency are areas where Japan has some very competitive companies that can supply solutions to the regulatory and productivity needs of customers globally. COVID-19 has also accelerated trends in ecommerce and digital transformation needs of companies. As profits recover, companies will prioritise those areas. More ethical consumption is also likely to be important in business to consumer facing companies.”
Nalaka De Silva, Manager of Aberdeen Diversified Income and Growth Trust, said: “Looking out over 2021 and beyond we see the best return prospects in a number of alternative asset classes, which we look to access in liquid and illiquid formats. This includes infrastructure assets that have attractive and reliable yields with inflation linkage. It also includes private credit and asset-backed securities which are offering significantly higher spreads than corporate bonds for similar levels of risk. Finally, there are a range of more niche asset classes such as healthcare royalties and litigation finance that we expect to deliver good returns over the next five years.”
Reasons for caution
Craig Baker, Global Chief Investment Officer of Willis Towers Watson and Chair of the Alliance Trust Investment Committee, said: “Financial markets always face uncertainty but as we enter 2021 there is more reason than ever to be cautious and avoid betting on particular countries, sectors or investment styles. We are in the midst of a global pandemic and, despite positive news on the vaccine front, there is still a lot that could go wrong, not least the policy responses which could vary widely between governments. Any rise in inflation expectations or significant tax changes could dramatically affect the style or sectors driving the market. For that reason, we think it’s vital to have a diversified portfolio focused on stock selection rather than macro factors as its key driver.”
Sam Morse, Portfolio Manager of Fidelity European Trust, said: “The one reliable prediction is that we should expect the unexpected. When asked this question in 2019, how many portfolio managers predicted a global pandemic? Having said that, the most likely ‘surprise’ is that earnings don’t recover to the extent that analysts are predicting, leading to disappointing stock performance. We are also keeping an eye on the US, where we are wary of slowing growth. If the GOP retain the Senate, then we could see political gridlock and President-elect Biden may be unable to pass the stimulus package that the market is expecting.”
James Robson, Chief Investment Officer at RM Funds, the investment manager of RM Secured Direct Lending, said: “Near-term optimism for markets should see new highs for European markets as those under-invested move into growth assets over the next 12 months. However, risks are building. To my mind near-term optimism is dampened by a medium-term negative outlook as we really are at the tail end of the economic cycle. RM Funds have navigated the crisis well – in fact the defensive nature of the products the funds manage are well suited for investors who have a cautious outlook.”
1. The poll was conducted with AIC member investment company managers (ex. VCTs) between 9 and 30 November on an anonymous basis. Responses represent 14% of total member assets excluding VCTs as at 31 October 2020.
Pot of gold
Ian Cowie reflects on the positives in his portfolio this year.
The coronavirus crisis dominated the global economy and investment returns during 2020, affecting health and wealth. But, while most media coverage focussed on bad news, the pandemic panic created winners as well as losers on stock markets.
For example, while the FTSE 100 index of Britain’s biggest shares fell 18% during 2020 to date (30/11/20) and is down 12% over the last 12 months, the average conventional investment company - that is, excluding Venture Capital Trusts - is up 12% over the last year, according to independent statisticians Morningstar. One explanation for investment companies’ performance providing a mirror image of the Footsie - the former were as positive as the latter was negative - is international diversification.
While uncertainty about Brexit depressed British share prices, others overseas were unaffected. The Standard & Poor’s 500 index, a broad measure of the American market, rose by 14% over the last year, while New York’s technology benchmark, Nasdaq, soared by 42%.
Coming down from the clouds, while this DIY investor knows next to nothing about artificial intelligence or computer code, I have benefited from digital developments for more than a decade as a shareholder in Polar Capital Technology (stock market ticker: PCT). Shares in this £3.3bn investment company soared by 43% over the last year, having delivered total returns of 544% over the last decade, and PCT is one of my top 10 holdings by value.
Some pharmaceutical companies also delivered healthy returns from the quest to find a cure for the coronavirus and other afflictions. This is another area where I can claim little knowledge but have enjoyed big gains from more than a decade as a shareholder in Worldwide Healthcare (WWH); also a top 10 holding in my ‘forever fund’. WWH delivered total returns of 21% over the last year, after growing its £2.2bn assets by 499% over the last 10 years, according to Morningstar.
But it would be wrong to suggest I got everything right in 2020. My decision to sell shares with high exposure to China, after allegations of human rights abuses and worries about a trade war with America, has cost me dear in returns foregone so far. For example, my former holdings in Fidelity China Special Situations (FCSS) and JPMorgan Asia Growth & Income (JAGI) went on to soar by 77% and 31% respectively over the last year. Fortunately, returns elsewhere in Asia remained strong. Baillie Gifford Shin Nippon (BGS), a Japanese smaller companies trust that I have held for more than a decade and is also a top 10 stake in my forever fund, delivered total returns of 39% last year.
None of my ‘Big Three’ yields much, which was one reason why I added JPMorgan Japan Smaller Companies (JPS) to the portfolio last year, when it delivered total returns of 29%, and continues to yield 3.6%. Closer to home, Aberdeen Standard European Logistics Income (ASLI) is another yielder that benefits from the boost online retail has received from the virus hampering high street rivals. ASLI owns warehouses and distribution hubs needed to store and process many of the goods we buy online and its shares delivered total returns of 20% last year with 4.5% dividend income.
Partly because the coronavirus is airborne and causes bronchial disease, many governments around the globe have given extra emphasis to reducing pollution and improving air quality. America’s president elect, Joe Biden, has promised a $2 trillion stimulus for renewable energy and Britain’s prime minister, Boris Johnson, recently enthused about what he called “a green industrial revolution”. Both boosted my shares in Ecofin Global Utilities & Infrastructure (EGL), where underlying assets include solar and wind farms. EGL delivered a total return over the last year of 20% and yields 3.7%.
Income is important to this DIY investor because the prime aim of my ‘forever fund’ is to enable me to enjoy retirement, relying on dividends as a substantial element of total returns. On that point, it is notable that 2020 saw 51% of Footsie companies cut, cancel or defer dividend payments to shareholders but only 8% of equity-based investment companies were forced to disappoint investors’ hopes of income. That is a remarkable illustration of investment companies’ ability to smooth out some of the shocks of the stock market and sustain income payments to investors. While dividends are not guaranteed and can be cut without notice, no fewer than 19 investment companies have actually increased shareholders’ income every year for two decades or more.
Looking to the future, investors who lack a crystal ball must learn to live with a high degree of uncertainty. Will vaccines banish the coronavirus to history and enable us to get back to business as usual? Or will the ‘new normal’ make our future lives very different from the past, with more of us working from home and spending more of our time and money online?
Like the ancient Greek philosopher, Socrates, all that I can be sure I know is that I don’t know. So one practical answer for investors is to diminish risk by diversification, investing across a wide range companies, countries and currencies.
A price worth paying
Faith Glasgow looks at buying investment companies on a premium.
If you were looking for evidence to demonstrate the growth of interest in investment companies over the past couple of decades, a key exhibit would have to be the emergence of the ‘persistent premium’. But what is that, and what does it mean for investors?
Historically, shares in most investment companies would generally trade at a discount to the value of the underlying assets they owned. If the discount then reduced, investors benefited from that additional boost to the share price; but received wisdom said shares that moved to a premium to net asset value (NAV) were unsustainable and heading for a correction, and should be avoided.
However, in the last 10 or 15 years that’s changed, and share price premiums to NAV – in some cases across entire sectors – have become a much more prevalent feature. In other words, even canny investors have become increasingly willing to pay ‘over the odds’ for certain investment companies.
To put that into context: Simon Elliott, head of investment trust research at broker Winterflood, reports that of the 320 or so funds in the firm’s universe, around 100 are now trading at around NAV (‘par’) or on a premium. Among the sectors where average share prices have sat almost exclusively at a premium over the past year are Biotechnology and Healthcare, Infrastructure, and Renewable Energy Infrastructure, though others, including Environmental and Technology, have also traded above par for lengthy periods.
The Baillie Gifford China Growth Trust has traded at a wide premium since the change of manager and mandate
Investment companies in the AIC Renewable Energy Infrastructure sector tend to trade at substantial premiums
So why have persistent premiums become so much more commonplace, and how should private investors approach them?
There are several reasons for this shift. In part it reflects changes in the investor base. This was formerly heavily dominated by big institutional investors looking for good value and wealth managers playing a shorter-term discount and premium game, but the last decade or so has seen considerable growth in retail investors saving into SIPPs and ISAs – often regular savers thinking about the very long term.
“Long-term retail investors are less discount or premium-sensitive and will buy if they like a company, even if it’s trading on a premium,” explains Elliott.
He gives the example of the former Witan Pacific trust. Prior to the market crash in February/March this year, it was trading on a fairly consistent 8-9% discount, but in September management passed to Baillie Gifford – a firm that has a large retail presence and whose star has been firmly in the ascendant. The renamed Baillie Gifford China Growth trust shot to a massive 34% premium, though it has since come back to around 12%.
Another factor in the emergence of premiums is the growth in funds invested in alternative assets. According to Ewan Lovett-Turner, head of investment companies research at broker Numis, alternatives have accounted for around 75% of the new investment company shares issued in the last six or seven years, and “have changed the dynamic” of the closed-ended landscape.
Alternatives investment companies – unlike conventional investment companies focused on listed equities – hold illiquid assets such as infrastructure, property and private equity. Valuations are more subjective and less frequent, and in some cases focused on historical cost rather than prospective earnings. In other words, net asset values may be based on pretty conservative valuations, and investors paying a share price premium in such cases are aware of that chronic undervaluation.
Importantly, certain alternatives sectors also offer a dependable yield, typically of 4-6% and in many cases substantially government-backed, which many people are prepared to pay for in these days of near-zero interest rates. The Infrastructure sector, for instance, currently has an average weighted yield of 4.6% and trades on a premium averaging around 17%.
“I know of value-oriented investors buying these alternative funds on premiums, sometimes quite substantial ones. When you have harder-to-value assets there can be more justification for a more structural, embedded premium, especially as people look more to that yield and how it compares with other cash flows such as fixed income,” Lovett-Turner explains.
The story is different for equity-focused investment companies on a premium – currently dominated by the Baillie Gifford stable. “Many Baillie Gifford funds are trading at consistent premiums on the back of strong performance and retail demand,” says Elliott. However, he adds, investors still need to be wary of extremes, as premiums can and do fluctuate with swings in wider sentiment.
Alongside the growing interest from the retail market has been a rise among retail-focused investment managers, including Baillie Gifford, JP Morgan and Janus Henderson, in the use of both discount control mechanisms (whereby the manager reduces the number of shares in circulation through buybacks, to avoid deep discounts opening up) and new share issuance, which helps avoid excessive share price premiums. These controls are particularly important in reducing the risk that private investors lose out by buying at excessive prices, and they therefore help these trusts to continue to attract new inflows.
Infrastructure investment companies usually trade at premiums to NAV
Simon Elliott makes the further point that the increased prevalence of premiums is a function of the way investment trusts are now traded. “In the olden days, market-makers looking to meet a surge in demand for a particular trust could always find an institutional investor willing to take some profit and surrender some shares,” he observes. “Nowadays, buy-and-hold strategies are much more widespread and it’s quite difficult to be that proactive.”
In effect, re-ratings occur partly because market-makers don’t have any easy calls to make to find stock for buyers – which is where new issuance comes in. “It amounts to a virtuous circle as investment trusts become more mainstream,” Elliott adds, with managers benefiting from growth in the size of the fund and investors in turn seeing costs fall through economies of scale.
So what should investors bear in mind when they encounter an investment company trading at a premium? It’s useful, first, to get a sense of how significant the differential is in historical terms. Various websites including the AIC's provide detailed statistics on discounts and premiums, and these are a useful place to start.
The most obvious check is to see how the current premium of the fund you’re interested in compares with its 12-month high, low and average levels. If the premium is at the upper end or out of sync with its annual range, more homework is clearly warranted.
“Then you really need to understand the fundamentals,” says Lovett-Turner. “Think about the valuation of the underlying assets. Listed equities are liquid and a high premium can be vulnerable and dangerous, whereas alternatives valuations are more subjective and less frequent, so it’s worth investigating the basis of the valuation. Look also at the yield and ask whether it justifies a premium rating.”
The bottom line is that, whatever type of investment company you’re looking at, it’s important to do your homework – and if you’re paying over the odds, be sure you understand what’s underpinning that premium.