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July 25, 2008 6:24 pm
Investors hoping to bag a bargain in the uncertain markets could turn to investment trusts, say analysts.
While discounts are not as wide as they have been in previous market downturns, a number of areas look very good value.
“For investors prepared to take a long-term contrarian view, current market levels may prove an interesting entry point,” says James Brown, an investment trust analyst at Winterflood Securities.
Brown accepts there is still significant downside risk in the short term, but says earnings multiples for most sectors are on historically low levels. He believes prices already reflect a significant fall in values.
The investment trust sector with the largest average discount is property.
“The current discounts in property are a buying opportunity,” says Daniel Lockyer, a fund manager of the Iimia investment trust. “People believe the discounts are overly pessimistic.”
Invista European Real Estate, for example, is on a wide discount of 67 per cent. Lockyer says: “If I didn’t already own Invista European I would be buying at these levels.”
But he warns that investors need to be selective and look beyond the discounts.
“Anything that’s highly geared I would tend to avoid,” he explains. Invesco Property Income, trading at a 63 per cent discount, is an example.
Private equity funds are also looking good value. Funds in the Private Equity Direct sector, for instance, are trading on an average discount of 25 per cent.
The large discounts reflect uncertainty over whether there is a long-term future in leveraged buyouts.
“These fears are excessive but they may come to light,” says Lockyer. “But if you have a view that these things are just going through a cycle and will come out the other end, then these are good buying opportunities.”
He recommends funds investing in private debt, such as Partners Group. “I think private debt is going to be a good area for returns going forward as businesses either can’t go to the banks at the moment or it’s more expensive for them.”
Nick Sketch, senior investment director at Rensburg Sheppards, the wealth managers, recommends studying the long-term performance of private equity funds.
“If you look at their track records it doesn’t matter what their discount is. The difference between the best and the average is too big to ignore,” he says.
His favoured trusts are from SVG, 3i, Candover
and Electra. Of these, SVG
is trading at a 40 per
cent discount. Sketch cannot see a good reason for this great a discount, so believes it is a good buying opportunity.
In the UK smaller companies sector, he says “discounts are starting to look appealing – and a few look very appealing”.
Standard Life UK Smaller Companies, for example, is among the top 10 performing investment trusts over the past six months and is trading at the highest discount of the 10 at 16 per cent.
But looking at the current discount of the fund may not tell the whole story. Brown suggests people look at the “z score”, which shows how much an investment trust has deviated from its average discount over a 12-month period.
While he admits the past 12 months have been an exception, Brown says the long-term rule is that a trust will eventually go back to its average discount. Trusts trading at larger than average discounts could therefore be worth buying.
“If you can get something at a nice wide discount where they have a much narrower target that does make sense,” says Brown.
But he adds that investors need to make sure the board of the trust is doing a good job. Funds that try to meet their discount targets, through buybacks, for example, may be attractive to investors because they can offer better liquidity for those wanting to sell.
Investors also need to be aware of the reasons behind the discount. For example, RAB Special Situations, a hedge fund, is trading at a 39 per cent discount. This is in part because the trust, which specialises in buying undervalued companies, bought shares in Northern Rock last autumn.
Brown says it is a “very difficult company to value” because it has not disclosed how it is valuing its Northern Rock holding.
“To buy into RAB Special Situations you’d really have to understand what you’re actually buying into,” warns Brown.
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