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@TI: A beautifully written & thoughtful taxonomy of opportunity and risk. 🙂
My 2 cents worth:
– Infrastructure & renewables discounts perhaps (more or less) fully explained by their interest rate exposure (5-9x negative correlations). I’m rather less negative than you are here in that the case for inflation linked income secured on high quality assets trading on 10-20% discounts looks to me to be quite promising overall.
– Listed PE (I hold some HVPE) impacted also by concerns over asset (re)valuation methodology & existential investor angst over whether the whole PE businesses model’s now a busted flush (after 40 yrs of expodentially increasing funds to deploy into a falling rate, increasing deregulation environment, with an opportunity set of target companies which has, arguably, not grown nearly as fast). Also I think public & political mood has soured on PE, at least on this side of the Atlantic. Then again, I’ve dipped my toe in with HVPE as, when the discount hits over 40%, you have to start to wonder if all the bad news isn’t already fully in the price. Also, IIRC, Vanguard are now involved with them.
– FWIW, IMHO the commercial property IT sector is likely a quagmire where the duds now greatly outnumber those with really decent risk tradeoffs. Good luck telling them apart!
– Exotics are a mercy killing. In future it will be other fads/fancies & doubtlessly some investors will make out like bandits, but I doubt that any of the so far surviving crop of speciality ITs will make it to party like it’s 2021 again.
– Solid growthy stuff like SMT and RCP (which some say is a defensive, but I don’t buy that & I hold both it & SMT for growth exposure, especially in unlisted) should do well if & when the cycle finally turns. Obviously, like every bag holder in SMT, I really hope that it doesn’t turn out to be another ARK Innovation. Hopium isn’t a strategy of course, but sometimes it’s all we’ve got as investors. Buying in around £7 gives some margin of safety (fingers crossed). At least with RCP you can fall back psychologically on the knowledge you’re coinvesting with the Rothschilds, & that you can’t really get much better pedigree / investment chops than that if you take a 200 yr view (they made their mark financing the UK during the Napoleonic wars).
– The big disappointment for me has been the ‘capital protection’ ITs (CGT, PNL etc). Sure, the performance hasn’t been that bad in % down terms, but these trusts were meant to hold their value & be all weathers. So much for that. It’s now the worst performance streak for CGT in the manager’s 41 yrs at the helm. I’m sticking with CGT, but I feel the loss much more acutely than bigger losses elsewhere.
– IMO, UK income focussed ITs should be a sound choice for decumulators at these prices/discounts.
Once again, thank you @TI for a really magnificent piece & my apologies for any typos as this is being typed on a rather grim, bone shaking, two hour bus journey across the north of England.
@TI. I tend to agree that closed-end trusts are probably a source of value here. The average discount available is hard to justify. I put it down primarily to IT’s having a large retail bias. Most of these funds are small in institutional terms, despite their long-track records, and liquidity is low. Retail was very long of them during the ultra low yield years, and with depos now at 5%, demand has weakened, while selling increased. We saw some equally extreme premiums only a few years ago.
The problem is sorting the wheat from the the chaff. There is a component of the discount that is due to forays into illiquid/less easy to value securities that may well be only realisable now at major discounts to NAV. There is an impact from needing to fund debt at higher rates. There is a bias toward “carry” that looks vulnerable with rates at 5%.
My own approach here is to just buy a broad basket of UK equity focussed ITs. I’m very light UK equity in tracker type funds and this is one way to hold a bit more at cheaper levels. I don’t feel I can pick the winners and dodge the losers, so I just want to monetize that average discount. So those with a strong return correlation to the FTSE at a decent discount look ok.
I’m avoiding stuff where they underlying is illiquid. Mainly commercial property or private equity. I’ve never really liked either. I have no interest in the defensives such as CGT, PNL, since I think I can replicate those cheaper/better with hedge funds. I am interested in some of the infrastrature ITs since I think they offer a way to lever a downside yield move, and thus offer an alternative to long duration bonds. It’s a minefield though since there is clearly a lot of toxic waste was built up in these portfolios over the past decade.
I’m surprised (i.e. lost money) how much they’ve derated. I think the problem isn’t just that cash yields 5%, it’s that cash yields 5% *tax free* in Gilts (or Linkers, pick your poison). That’s a mighty hurdle to overcome when the outcome looks uncertain.
That said, rates do now seem to be heading lower (until inflation ticks back up?). I’ve just tickled in some 3IN and some TRY, let’s see..
> “I’ll very likely talk about specific investment trusts again in Moguls in the months ahead” <
It would be great (and much appreciated) if you might perhaps be able to include in any future Mogul pieces on specific investment trusts the occasionally overlooked trusts in the loans and bonds, structured finance and direct lending sectors.
Aside from the comparatively well known stalwarts (e.g. CVC Income and Growth, TwentyFour Income, CQS New City High Yield, Henderson Diversified Income, and NB Global Monthly Income); there's also now a few truly astonishing yields out there (e.g. Marble Point Loan Financing, @17%; and Fair Oaks Income, @15.2%).
Contrary to all of my prior expectations, the trusts in this sector with the highest yields all sport some of the smallest discounts.
@TLI — Thanks for the encouraging and generous review of the piece, and for adding your own views on the value out there. I’m also holding SMT, albeit I started buying it around £7-8 (no cigar, I had a ton of other smashed up disruptive growth in 2022) and have been trading it (and stablemate USA) very heavily. While this year has been okay for me, it would have been a lot better if SMT didn’t exist, as my initial move out of most of that disruptive growth was into PCT and ATT (very Magnificent Seven adjacent) on strength of cashflow grounds, then I reasoned if they did well then SMT/USA would probably do better… my initial beaten up stocks would have done better, followed by the large cap trusts, and the ‘geared into a recovery’ play of SMT has done by far the worst. And the logic wasn’t utterly off, going by the performance of Ark Innovation, albeit the extreme element of the outperformance versus SMT has come pretty late in 2023. (Ark is up nearly 60% YTD, in case you were not aware). I continue to hold, might add. Ho hum.
Re: the leveraged debt funds, sorry to disappoint but I’m not very likely to dive deeply into these as a group. Well outside my day-to-day. That said if I decide one is special situation or similar, you never know… Do feel free to share your thoughts here though, I’m sure other Moguls would enjoy the read/learnings! 🙂
@ZXSpectrum48K — As ever pretty much agree with all that. RE: the infrastructure trusts, I am just wary of what the market is pricing in here. The inflation-adjusted element to the future income seems transparent and well-broadcast. Some discounting of assets was warranted but the market seems to have gone from euphoria to despair (30% premiums to NAV to 20% discounts or worse). Is it all retail investors and wealth managers bailing into gilts/linkers, or has it sniffed out something more existentially threatening? I guess I don’t like the asset class enough to try to really find out/take a huge position, though as I say I’ve got a couple of small holdings (c. 1% in each) for now.
@Vroom — Agreed but the tax-free element won’t last forever, right? At some point the very low coupon gilts should roll off. Meanwhile these are generally holders of proper businesses, in theory, investing for growing long-term returns. I wonder in a decade if the dash for 5% and very low duration will look like grabbing a bird in the hand and letting three in the bush go begging? It’s not like we’re being offered what seem like high yields while every alternative looks expensive (the situation in 1999, as a contrast, although I suppose you could buy cheap value/old economy stocks then).
@Vroom & @ZX summarise the problem more eloquently & succinctly than I can.
Getting paid ~5% tax free to wait out the carnage in short duration, low coupon linkers in 2023 is actually a viable option, especially when equities (though not in 1999 territory, by any means) are far more richly priced than in 2009 (when you got nada for sitting out the fear, uncertainty & doubt in cash, which was my own mistake back then).
Add to this the leverage/refinance costs, liquidity issues, uncertainty over unlisted holdings, plus outsized exposures to the commercial property & small caps sectors; well, it’s not hard to see why many ITs have gone from flavour of the month to almost untouchable. But in uncertainty & fear there is opportunity & reward.
@TI: Fraid I’ve got no special insights about debt trusts; or anything else, for that matter 😉 Lol. I did see though in October that the Z-score (not Altman’s Z score) for Fair Oaks Income IT had hit a scarcely credible -3.8, which is well into a screaming anomaly. This got me thinking about the debt trust sector. Undercovered by analysts, somewhat esoteric in places; but also neither novel, nor untested. IIRC HY debt trusts (& funds) did well coming out of 2009 (albeit still lagging well behind the then returns’ pacesetters of SPY and QQQ).
@ TI, there are low coupon Gilts all along the curve. e.g. the TG61 (21/10/2061) has a 0.5% coupon and trades at 28.9p (will redeem at 100p). The TG50 (22/10/50) has a 0.625% coupon and trades at 38.7p which is a ytm ~ 4.60% mostly tax free for 27 years. Or 0.125% coupon linkers to similar end dates at real yields of 1.3%.
The better point as you say is the 3 birds in the bush, when do you jump from low duration 5% safety into something for the longer term? The ‘classic’ move is to jump into duration at the first rate cut in the cycle, but has there ever been a more anticipated/front-run position? 10y bonds and all of the related plays have already done a lot of work. True it’s likely they’ll do a lot more if/when we do go into rate cuts. But might there yet be another twist / better entry point before we do get that first cut?
& then further down the track is that “it”? Are we back to tame inflation and ZIRP? My best guess is no (paging Russell Napier etc), but it’s all a bit ???
@Vroom — Cheers for the extra detail! Must admit that aside from early interest six months or so ago (when I should have written about the low income tax play here on Monevator) I’ve almost exclusively been focused on boning up on longer duration linkers, so that’s a good learning for me.
Interesting point whether UK duration has been front run. (Can we really say this about fixed income though? Maybe it’s semantics, but given return profile ‘pulled forward’ seems better to me…)
You could be right. I instinctively agreed wrt the US 10-year but when I look at the 10-year gilt it is the same sort of move.
I’m very much a tourist on government bonds, and welcome all opinions!
Sneak advance notice for Mogul members — the Mavens members post tomorrow is a DIY linker ladder extravaganza. 🙂 I expect a lot of interest and comment, and I’m glad the recovery seems to have stalled at least for long enough for us to get this article out… 😉
Following on from my earlier posts #4 & 6 above, Fair Oaks Income and many other HY debt trusts, on further investigation / due diligence, seem to have more red flags than a Soviet parade on May Day. That doesn’t necessarily mean they’re no go, but there looks to be onion layers of complexity & uncertainty around them; hence perhaps the fantastical looking notional yields of some. New City (along with TwentyFour Income), with (for CQS NCHY) its more believable ~9% yield, seems to get the cleanest bill of health & the manager appears to be held in very high regard by those professing to be in the know about the sector. An awful lot appears to rest on his own experience, expertise, skill & judgment though, as much of the debt held is unrated.
FWIW, some telegraphing in the financial press that renewables ITs may not have seen quite as big a boost from downward changes in interest rate expectations since Oct because (in their opinion/guess) there were elements to the pricing of such trusts in late 2022 that were based upon expecting even higher energy wholesale prices by now. Whilst it’s hard to believe when you’re looking down the barrel of 28p/kwh for electric on the retail price cap; back during the mad queen Truss’ and Kamakwasi’s brief stewardship of the economy, ‘This is Money’ (the DM’s PF section) reckoned that, absent any subsidy, electric could have hit 117p/kwh that winter (2022/3); which would have been unimaginable if it had happened (and thank God it didn’t). But any such elevated pricing expectations may have then worked their way into some of the DCF analysis, such that some of the renewables trusts now have to work that off as well as dealing with the lingering effects of rate hikes, both on their own costs and on the discount rate for their future cash flows.
A word of caution – some discounted listed Private Equity trusts/companies have alarmingly big bid/ask spreads to buy/sell, i.e. 4-7%. There’s plenty at much more reasonable levels, but, personally, I’m reluctant to eat a more than 1% spread and draw the line at anything over 2%.
MoneyWeek’s warning to steer clear of ITs with, in its view, deserved discounts such as DGI9, GIRO & SONG.
In contrast, HVPE, HGT, PIN, OCI and ICGT elicit more positive comments from MW with, in MW’s view, the extent of their various discounts being more or less inexplicable.
Elsewhere in MW this week they also like 3IN and UKW.
There’s a question here for ITs as to how much differences in discount levels across and within IT sectors are attributable, on the one hand, to varying levels of credence in reported NAVs and, on the other hand, to the overall prospects (risk adjusted, and suitably discounted) of the underlying investments within each trust?
At some level these issues are probably linked.
If an unlisted investment held by an IT is overvalued at book price for NAV purposes as compared to an open market price (if the holding was sold now) then the investment is likely going to be worth less in the future too in terms of each of its probable sustainable sales growth rate, its time to transition to profitability, and its likely future operating margins.
But there’s not necessarily a clear sector by sector pattern.
Traditional PE trusts (e.g. HVPE) suffer due to valuation opacity concern. REITs and infrastructure ITs each have funding sensitivity to rates. Meanwhile ‘growth’ trusts in unprofitable tech are exposed to higher discount rates on projected future cash flows.
Yet it seems not immediately clear why (at the end of last month) a renewables trust like, say, Premier Miton Global, was only trading at a 16% discount to NAV, whilst a sensible alternative trust like, say, Foresight Sustainable Forestry, chalked up a 30% discount.
Or, for that matter, why a very long established and successful multi asset trust like RCP still languishes at a 27% discount, far more than, say, SMT; which is of younger pedigree, more speculative and less diversified.
Even less comprehensible (to me) is why trusts, like PSH, made up as they are of liquid, publically traded securities, should be on a discount at all; e.g., even after a welcome 30-40% recent price ramp, PSH still trades at a hefty 25% discount.
It’s all a bit of a mystery.
@Delta Hedge — It certainly is a mystery and I guess it has to be for these discounts to exist or at least vary so much. If we could easily discern the reasons for discounts in all cases, then they arguably wouldn’t manifest, or at least there’d be some ‘science’ to them.
There is no science to them, they are 3D chess (underlying portfolio with a holding company layer on top, both varyingly attractive to investors).
I talked deliberately about ‘fashion’ in my recent AUGM post because I think that’s as good as any description. Some people try to make investing more precise than it really is. Emotions and fashion and all sorts matter. Knowing this doesn’t make it any easier to profit from potential disconnects, sadly. 🙂
For a nice example of fashion in the collectible market, check out how luxury watches have boomed and bust:
https://twitter.com/MerrynSW/status/1764971702490976275
Market prices reflect/include uncertainty. The underlying portfolios have some specific value, we just don’t know it yet and even if we did then events in the next five minutes could change them. Hence we must approach discounts and NAVs humbly. I believe there are always opportunities here, but not all discounted trusts are opportunities.
Just ask the unfortunate holders of music royalty trust SONG who saw their NAV written down by 26% this week…
Just to follow up my comment above on being humble, I think Nicolas Rabener put it well this week in his opener to a factor article:
https://insights.finominal.com/research-value-vs-quality-more-correlated-than-ever/
I just had a windfall and was looking for places to put it. I don’t normally trade, so I found it really useful to look back at previous Moguls and Members posts and have a quick review.
They are a fantastic resource, thanks for writing them. Your writing is interesting and valued even if I don’t comment on articles much.
My intuition is to buy a mix of UK equity indexes (due to the UK market being unfavoured) and some investment trusts on a discount, such as the ones mentioned here.
Each time I find a trust I’m interested in, I search my emails for any Monevator.com post mentioning it for some extra intel/context. So I really wouldn’t mind if Moguls turned into an Investor Trust monthly type newsletter. The analysis is always well explained, so I can learn from it even if I have no interest in the company in question.
@Markabey — Thanks so much for your generous comments (as well for signing up of course! 🙂 ) The chances are that over the cycle this extreme discounting phase will wane and I’ll be writing more about stocks than investment trusts I imagine. That’s been how my interest has shifted over previous cycles anyway. But for now I still find it hard to overlook the £1 coins trading for 90/80/70p, especially when that discount is a fact not an opinion. 🙂
@Delta Hedge — I have just come across the perfect deep dive into the potential drivers of closed-end fund premiums/discounts for you:
https://www.acadian-asset.com/investment-insights/owenomics/stupidity-is-our-destiny-historic-closed-end-fund-overpricing#main-section-6
Thank you @TI. I’m putting some time aside this weekend to read & inwardly digest 🙂 To the extent that there might be a separate illiquidity element, as distinct from ‘pure’ valuation uncertainty, to the implied discounts on unlisted investments held by ITs; then might the so called ‘Inelastic Markets Hypothesis” have some bearing?:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3686935
Nick Train super optimistic on UK value in statements reported yesterday. I’ve shoved 1% of ISA into his LTI IT on ~6% yield. At one stage this traded at a frankly ridiculous 75% premium. Recently it’s hit a 20% discount.
Elsewhere, Ian Cowie at ii highlighting today the UK energy infrastructure ITs – BSIF, TRIG, Gore Street, Greencoat Wind, Ecofin.
As always, who knows (?) and DYOR.
@Delta Hedge — Be aware that the price (or more particularly the NAV) of LTI is driven in large part by its huge holding in LTL, the fund management business run by Train and Michael Lindsell. This has been losing assets at a prodigious rate. Shockingly, it lost something like a £1bn in its last update despite UK markets firming (suggesting some kind of mandate loss). I’ve been playing cat and mouse with LTI for two years to a modest loss overall, and I still have about 1% of the portfolio in it as of this typing, but it’s important to know it’s not just a play on UK equities. His Finsbury Trust (FGT) is a better bet there IMHO, though the discount is more modest (something like 7%, I hold too).
Of course if UK assets go on a tear and LTL shoots the lights out you could see geared upside, too. 🙂 But that ‘If’ has been a long time coming 😉
Interesting. Thank you @TI. I knew about LTL, but not about the likely big mandate loss.
Finsbury, on the other hand, although Train managed too, is veritable ‘royalty’ amongst the UK equity income investment trust sector; so I’m inclined to agree with your assessment that -7% is ‘better’ here than -20% as a discount to quality.
Aside from being wedded by fear of idiosyncratic and concentration risks to overwhelmingly being in trackers; a practical impediment to increasing the % allocation of the overall portfolio going into ITs which I’ve realised recently is that, for anything with above market risk, like ITs (and more so of course for individual company shares), it can be useful to use a GIA to hold it rather than a tax wrapper as, if it all goes a bit Pete Tong (as they used to say in my youth) then at least upon sale the capital loss becomes available to offset chargeable gains elsewhere in the GIA.
This is especially useful as claimed losses for CGT can be carried forward, once claimed within 4 years, and then utilised against gains without time limit.
But if you have ITs in a GIA and not in either a SIPP or an ISA then you also pay income tax on the dividend income (after using up the de minimis £500 annual dividend allowance, which doesn’t stretch far).
Holding zero dividend ITs like listed PE behemoth HVPE or our Global Macro favourite BHMG solves this dilemma; but as soon as you start using the GIA for buying UK equity income, infrastructure or renewable ITs currently sporting 6%, 7% or even 8% yields then you’re into paying a fair bit of income tax on the dividends.
You can shove those HY dividend payers into a tax free ISA or SIPP instead, but because there there’s no CGT liability for assets held in an ISA or a SIPP then there’s also no possibility of using up realised capital losses there if the investments go badly. This, in turn, increases my risk aversion a notch on these active punts.
DT today tipping Greencoat UK Wind, JLEN Environmental Assets and Impax Environmental Markets to perform well under Labour [I don’t read the right wing press other than for the business and market coverage 😉 ]
FWIW, I’m personally not convinced, unless there’s going to be manifesto commitments to improve the incentives structures for renewables generation and/or for more government investment to help reduce the backlog with actually getting projects connected up to the national grid.
A cautionary take on long term IT head winds from David Stevenson, writing for AIC and CityWire on 11th June:
https://www.theaic.co.uk/aic/news/industry-news/david-stevenson-if-not-wealth-managers-who-will-buy-exotic-trusts
Just come across an interesting piece from Richard Evans of Fidelity from July 2024, the salient summary of which is that:
– the average IT discount has narrowed from 17% in October 2023 (the largest since 2008, at 18%) to just 5.4%, which isn’t too far off typical 2009-21 levels (we only went to an average premium in 2017/18).
– notwithstanding this, “of the 371 trusts listed in London, just 23 currently trade at a premium…while the other 348 trade at a discount. Only 4 trade at a premium of 10% or more whereas 224 are at a double-digit discount”.
The Lemon Fool PF site has a very comprehensive list of all ITs and closed-end funds which, as of December 2023, had a trailing dividend yield over 3.5%. I won’t link here, as the amount of detail is a bit overwhelming. However, I found 70 trusts/CEFs on the list with a yield of at least 7%, of which 35 are both available on HL and were listed with a higher yield of at least 8%. Those included CHRY and several others which actually no longer appear to be paying a dividend. This then raises the counterintuitive problem that some of the most discounted trusts with the highest historic yields are in financial difficulties and may, perhaps, be less attractive as investments than the less substantially discounted trusts with notionally lower trailing yields. ‘Cheapest’ may not be best.
P S. – for context, I should also include here Mr Evans’ caveat on that 5.4% average figure: “That figure of 5.4% may not sound like much but it is distorted by the giant premium on 3i’s shares….Because of that big premium and because of the sheer size of 3i as a business (at a market value of £30.5bn it is far and away the largest investment trust), the effect on the average discount is huge: if we exclude 3i from the calculation, the average investment trust discount jumps to 14.6%.”
@Delta Hedge — Yes, that caveat is pretty critical! 🙂 3i completely distorts all discount/premium figures as pertains to the average trust.
There was quite an interesting podcast episode about 3i on Business Breakdowns recently. Essentially it’s a bet on a European discounter called Action Company:
https://open.spotify.com/episode/7bjrLQKnfVPRyVKGf5yCur
An insanely good investment no doubt, but it’s very hard for me seeing it having a moat to justify that sort of overweight in what’s purportedly an investment company.
Better to see 3i as a European discount retailer trading at a high multiple with a fairly chunky private equity subsidiary 😉
Breaking news! The FCA has temporarily exempted investment trusts from the PRIIPs regulation blamed for inflating costs:
https://www.fca.org.uk/news/statements/forbearance-relation-investment-trust-disclosure-requirements
Some industry response:
https://portfolio-adviser.com/fca-temporarily-exempts-investment-trusts-from-priips-regulation-in-light-of-cost-disclosure-issues/
Thanks for covering the FCA changes in the weekend reading today @TI.
I’m not sure how much the rule changes will actually help here.
In principle, full and frank costs disclosure should be a net good but, clearly, the ITs should also be permitted to set out in their costs info. why, in their opinion, the costs figures they have to report are not fully apples to apples with the other types of investment vehicles.
Investors are adults and can then make up their own minds.
Plenty of firms have to report their performance figures using their country’s of incorporation version of GAAP, but still include notes to their accounts to say why they believe that this is a misleading presentation of their financial position in their specific circumstances.