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Riding out the storm – Kepler Trust Intelligence

20 May 2022 Performance, About Alliance Trust Kepler Trust Intelligence

Many investors are attracted to investment trusts for the discount opportunities: e.g. for the chance to buy £1 of assets for 80p or less (see our Discounted Opportunities Portfolio for some potential examples). However, particularly in volatile market environments such as today’s, some investors may be put off by the uncertainty that discounts bring: they may worry about the possibility of trying to ‘catch a falling knife’, as it can be difficult to call when a discount will rebound or when it will widen further. For this reason, many boards aim to keep the shares trading close to NAV, and some investors will consider this in itself as adding to the attractions of a trust by lowering the volatility and uncertainty. In this article we consider which trusts have the best record when it comes to discount volatility and the reasons for this, and what these trusts might bring to a portfolio.

 

Discount volatility

A volatile discount may leave some investors cold as it increases the uncertainty around the level at which they will be able to sell. A credible commitment by the board to keep the discount close to par may give some investors greater confidence to invest, believing they will not have to time their eventual sale around a volatile discount movement. We examined all listed equity and multi-asset AIC sectors, excluding trusts whose market caps were deemed too small (as they were below £10m) and multiple share classes of a single strategy. The below table shows the top 20 investment trusts with the lowest five-year discount volatility, i.e. those which can demonstrate the most stable discounts over recent years.

 

TRUSTS WITH THE LOWEST DISCOUNT VOLATILITY

NAME

SECTOR

FIVE-YEAR VOLATILITY (%, ANN.)

FIVE-YEAR AVERAGE DISCOUNT/ PREMIUM (%)

Personal Assets

Flexible Investment

0.43

1.15

Capital Gearing Trust

Flexible Investment

0.58

2.05

Alliance Trust

Global

1.09

-5.72

Troy Income & Growth

UK Equity Income

1.21

-0.23

City of London

UK Equity Income

1.26

1.64

JPMorgan Elect Managed Income

UK Equity Income

1.29

-2.88

AVI Global

Global

1.36

-9.29

JPMorgan American

North America

1.36

-4.77

JPMorgan Elect Managed Growth

Global

1.37

-3.07

Martin Currie Global Portfolio

Global

1.44

-0.28

Mid Wynd International

Global

1.52

1.99

Momentum Multi-Asset Value Trust

Flexible Investment

1.52

-0.12

BMO Managed Portfolio Income

Flexible Investment

1.55

0.96

Aberdeen New Dawn

Asia Pacific

1.58

-12.41

BMO Managed Portfolio Growth

Flexible Investment

1.63

0.60

Asia Dragon

Asia Pacific

1.69

-11.20

JPMorgan Global Growth & Income

Global Equity Income

1.71

2.05

BMO Capital & Income

UK Equity Income

1.71

-0.12

Fidelity European Trust

Europe

1.72

-8.11

Scottish American

Global Equity Income

1.81

3.53

Source: Morningstar, as at 11/05/2022

As the table above shows, Personal Assets (PNL) has demonstrated the lowest discount volatility of any investment trust over the last five years. PNL’s managers Sebastian Lyon and Charlotte Yonge follow a low-volatility approach to investing with a multi-asset portfolio of equity, fixed income and gold-related investments, aiming to “protect and increase (in that order) the value of shareholders’ funds per share over the long term”. While a conservative investment approach may certainly be attractive in today’s risk-off market, it is not the sole advantage of PNL, as it also operates a strict discount control mechanism (DCM), with a policy of ensuring that its shares always trade at close to net asset value. High demand for the shares means that PNL has been a net issuer for the vast majority of the last five years, having issued 470,000 shares over the last 12 months alone, c. 14% of its circulation.

Additionally, we believe that Alliance Trust (ATST) deserves special recognition as, despite trading on a discount on average, its board has been successful in maintaining a very low discount volatility. ATST offers investors a highly diversified approach to active investing, employing ten professional stock-pickers across multiple styles of global equity investing to create a c. 200-stock portfolio, with any active risks relative to the MSCI ACWI being diversified away by its manager, Willis Towers Watson. ATST’s board does not operate with an explicit target for the discount level, rather the board aims to ensure that the discount remains stable so as to avoid its shareholders being impacted by painful widening. Given the low volatility of ATST’s discount the board has clearly been successful in this regard, having bought back c. 6% of the current circulation of the trust’s shares over the last 12 months alone. We think the stability adds to ATST’s attractions as a core global equity holding.

While some of the above trusts aim to keep the share price as close to par as possible (using zero-discount policies), others set a wider target range (a -5% minimum, for example), and some merely state their intention to intervene in the market. Standout examples of the first type include Martin Currie Global Portfolio (MNP) and Momentum Multi-Asset Value Trust (MAVT). In the case of MAVT, its board has worked hard to ensure that the trust’s shares trade as close to its NAV as possible, having repurchased some 16% of its outstanding circulation over the last 12 months. Accordingly, a monumental 37% of the trust’s outstanding shares have been repurchased since the start of 2020. Ensuring a stable discount means that MAVT may remain attractive for investors looking for an off-the-shelf solution. MAVT offers a diverse portfolio of equities, credit and specialist alternative assets – albeit with a value-orientated approach – meaning it has the potential to function as a single investment solution for investors.

MNP on the other hand is a far more focussed, growth-orientated strategy with a concentrated portfolio of high-growth, high-quality global equities. Given the enormous headwinds facing that style of investing one would expect MNP to be caught up in the wider sell-off that many of its growth-focussed peers have seen in recent months, yet the trust operates with a strict zero-discount policy which has been implemented effectively by its board. MNP’s board has a comparatively large special reserve worth £70m (c. 30% of MNP’s current NAV) at its disposal in order to accomplish this. While MNP has been a net issuer of shares in recent years, the board has begun to buy back shares since October 2021, reflecting the beginning of the global rotation out of growth stocks. Demand for MNP’s shares has thankfully been robust, despite the powerful headwinds the style faces, with the board having only needed to repurchase 1m shares since 1 October 2021, a mere 1% of the current circulation.

Fidelity European Trust (FEV) stands out as the only trust which has on average traded at a discount over the last five years but has largely made little use of buybacks, meaning that the low volatility is largely organic. In fact, FEV’s board has only intervened in three periods in the last five years: a period between June and September 2018, during the COVID-19 crash in March and April 2020, and very briefly in August 2021. Even these transactions have been small, with FEV’s board having repurchased only 1% of its shares over the last five years. This means that FEV’s low discount volatility has been almost entirely the result of investor demand. Performance is clearly a factor, with FEV’s relatively strong performance making it the top-performing trust in the peer group over the last 12 months, and also the second best over the last three and five years. This has been an impressive feat given the fluctuations in stylistic tailwinds we have seen.

 

Average discount

It is arguably easier to maintain low discount volatility when a trust is trading on a premium. In the below table we look at the trusts with the highest average premiums over the past five years, and at their discount volatility. As can be seen, a high average premium does not necessarily indicate lower volatility.

 

TRUSTS WITH THE HIGHEST AVERAGE PREMIUM

NAME

SECTOR

FIVE-YEAR VOLATILITY (%, ANN.)

FIVE-YEAR AVERAGE PREMIUM (%)

Lindsell Train

Global

20.06

25.07

Syncona

Biotechnology & Healthcare

14.71

19.29

Geiger Counter

Commodities & Natural Resources

7.40

6.46

RTW Venture

Biotechnology & Healthcare

6.92

6.14

JPMorgan Global Core Real Assets

Flexible Investment

7.84

3.78

Scottish American

Global Equity Income

1.81

3.53

Baillie Gifford Shin Nippon

Japanese Smaller Companies

4.29

2.83

Augmentum Fintech

Technology & Media

13.31

2.35

Smithson

Global Smaller Companies

2.29

2.31

Baillie Gifford US Growth

North America

3.77

2.27

JPMorgan Global Growth & Income

Global Equity Income

1.71

2.05

Capital Gearing Trust

Flexible Investment

0.58

2.05

Mid Wynd International

Global

1.52

1.99

RIT Capital Partners

Flexible Investment

7.12

1.96

AVI Japan Opportunity

Japanese Smaller Companies

2.83

1.80

Monks

Global

2.92

1.66

City of London

UK Equity Income

1.26

1.64

Baillie Gifford Japan

Japan

3.89

1.43

Personal Assets

Flexible Investment

0.43

1.15

BB Healthcare

Biotechnology & Healthcare

2.03

1.10

We note that the above table does contain a handful of trusts with less than five-year track records
Source: Morningstar, as at 11/05/2022

When we considered the whole investment trust universe, we found a weak negative correlation of -0.13 between discount volatility and premium. Even when we sampled the 100 least volatile trusts, there was still a modestly negative correlation of -0.26. We note that both samples are statistically significant, which does go some way to supporting the notion that the trusts which trade at a premium have more consistent share price-to-NAV ratios, given that it is much easier to issue shares than it is to buy them back.

We think one reason why this correlation is not higher is due to the trusts which invest in unlisted assets in order to trade on hefty premiums, with strategies like Lindsell Train, Syncona and JPMorgan Global Core Real Assets either investing entirely in unlisted assets or having large exposures to them. Investing in unlisted assets creates an inherent propensity for higher discount volatility, as the share prices are likely to move much more than the NAVs because some or all of the underlying assets don’t trade on a listed market.

One thing that is worth highlighting is the large presence of Baillie Gifford-managed strategies, with five of the 20 trusts listed above being run by one of the company’s teams. The premium that Baillie Gifford trusts have commanded over the last five years is likely a reflection of the barnstorming performance they saw during 2019 and 2020, when many of these strategies ranked amongst the best-performing trusts in their peer groups. Baillie Gifford US Growth (USA) was the best-performing trust of any sector in 2022 in NAV terms. We note that the recent market drawdown has also opened up some discounts amongst Baillie Gifford strategies. Baillie Gifford European Growth (BGEU) now trades on a 9.5% discount that is 14% below its 12-month high, while USA trades on a 13% discount, more than 20% below its 12-month high.

 

The magnificent seven

Below we have identified those trusts which have delivered a low discount volatility while trading on a premium to NAV over the past five years. Arguably this is a sweet spot for investors, although it does reflect the strategies that have been in demand over the past five years, which may not be the most favoured over the next five years as well. The below table shows those trusts that are in the top decile for both the average premium they trade at and their level of volatility (a slightly wider sampling range than the top 20 we have shown in our prior tables).

 

TRUSTS THAT COMBINE A LOW DISCOUNT VOLATILITY WITH A HIGH AVERAGE PREMIUM

NAME

SECTOR

FIVE-YEAR VOLATILITY (%, ANN.)

FIVE-YEAR AVERAGE PREMIUM (%)

Personal Assets

Flexible Investment

0.43

1.15

Capital Gearing Trust

Flexible Investment

0.58

2.05

Mid Wynd International

Global

1.52

1.99

JPMorgan Global Growth & Income

Global Equity Income

1.71

2.05

Scottish American

Global Equity Income

1.81

3.53

City of London

UK Equity Income

1.26

1.64

BMO Managed Portfolio Income

Flexible Investment

1.55

0.96

Source: Morningstar, as at 11/05/2022

The above seven trusts are not only unified by all of them having discount-conscious boards, but also by the fact that their investment objectives may arguably suit buy-and-hold investors better: either those who are looking to draw an income from their holdings, or those seeking capital preservation. This group contains three equity income strategies, as well as three flexible strategies which offer diverse multi-asset portfolios, a ‘one-stop shop’ style of investing which is likely to appeal to buy-and-hold investors. We believe that the boards of both styles of strategy are likely to be conscious that their investors are looking for a greater degree of security in their investments. This means these investors are either able to ‘park and forget’ their allocations, or able to make regular investments into their accounts with less concern about timing the discount. We note that Scottish American (SAIN) offers one of the most growth-orientated strategies within its peer group, and while this has led its 2.7% yield to be one of the lowest in the global equity income peer group, it still ranks as the best-performing trust in its sector over three and five years.

Mid Wynd International (MWY) is the only trust in the above group that is not either an income strategy or a diversified multi-asset strategy. Instead it is a highly active, concentrated global equity portfolio. MWY’s stable discount is the result of its discount control policy, where under normal market conditions the trust’s board seeks to limit the discount or premium at a maximum of 2%, believing that it is in the interest of shareholders to maintain a share price that is broadly in line with the NAV. Another reason for this is the investment approach of the trust’s managers, Simon Edelsten and Alex Illingworth. While Simon and Alex take a thematic approach to investing, they are not married to any single style, and are willing to adapt their portfolio to the prevailing macro environment. In fact, the team have recently adjusted their portfolio to bring its P/E ratio below that of the MSCI ACWI for the first time since the managers took over, reflecting the broader market’s shift away from growth stocks. It is this proactive investing which has led MWY to avoid the pain of the broader market sell-off, and it ranks as the third-best performing investment trust within the global equity peer group over a five-year period, while having still stayed in the top 50% over the last 12 months. We think this is impressive given the enormous shifts in stylistic tailwinds over those two periods, and something which has likely kept the demand for MWY’s shares strong.

 

Conclusion

Discounts can be tricky things, often exacerbating market movements during times like today when investors are seeking safety, and potentially increasing concerns about when an investor will want to exit. While some investors may see discounts as an opportunity to capitalise on an enhanced upside, others may see them as a headache and another risk factor to consider when allocating capital. That being said, there are investment trusts which have operated with stable long-term discounts, often thanks to their boards operating with judicious discount controls. With markets highly volatile at the moment, a more stable discount could be especially attractive.

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