Extreme value in investment trusts
Investors should never take discounts at face value, but many funds offer a clear margin of safety
Investment trust discounts have blown out this year. Trusts are trading at an average discount of around 11% to their underlying net asset value (NAV) at the time of writing, according to the Association of Investment Companies. At times, they have been as wide as 17% – more than twice their long-term average.
However, these figures are just averages. Some trusts are trading at discounts as wide as 60%, while others are trading at premium. 3i (LSE: III), the UK’s largest investment trust with total assets of £19bn, is trading at a premium to NAV of 23%.
Ever the value-hunter, I’ve been paying close attention to the ones on large discounts. The allure of buying £1 of assets for 90p is too great to ignore. But no investor should buy a trust based on its discount alone.
A deserved discount
In some cases, investment trusts deserve to trade at a discount to NAV because there’s uncertainty about the true value of the underlying assets. This is mainly relevant to trusts with large allocations to illiquid assets, such as private equity and infrastructure. Just because a valuer thinks an asset is worth a certain amount, it does not mean a buyer will be willing to pay the implied price. That’s why investors should never take discounts at face value. Take a handful of trusts trading on discounts of 50% or more to NAV. That in theory means investors can pick up £1 worth of assets for 50p. However, some clearly have problems.
Ground Rents Income (LSE: GRIO), while yielding 9.8% and trading at a discount of 68%, is facing uncertainty about the future value of its assets – freehold ground rents – due to the government’s proposed leasehold reforms. Digital 9 Infrastructure (LSE: DGI9) is struggling with debt. Hipgnosis Songs (LSE: SONG) is in the middle of a strategic review after a shareholder revolt. Both are trading at discounts of 50% or more to NAV.
Margin of safety
On the other hand, Seraphim Space (LSE: SSIT) is a venture capital fund specialising in the space sector. It owns a portfolio of early-stage space businesses, which have a lot of potential but are difficult to value. Still, the 64% discount to NAV seems too pessimistic. A discount of 20%-30% would still give a margin of safety. The same can be said of HydrogenOne Capital Growth (LSE: HGEN), a venture investor in hydrogen.
Tetragon Financial (LSE: TFG), with £2.4bn of assets, is a hedge fund that owns a range of illiquid and liquid assets. The fact that part of the portfolio has a liquid market, with daily trading and prices, suggests its discount to NAV of 66% is also too pessimistic.
Then there’s Amedeo Air Four Plus (LSE: AA4), which I covered two weeks ago. The terminal value of the company’s assets – a selection of aircraft leased to Emirates and Thai Airways – is highly uncertain: the market for second-hand A380s is uncertain. The value here isn’t in the assets – it’s in the income from the assets. With a mid-teens yield and leases in place well into 2030, the company will be able to maintain its payout over the next decade. At the current yield, investors only need to hold the stock for seven years to earn all of their capital back.
HarbourVest Global Private Equity (LSE: HVPE) is the second-largest private equity trust on the market after 3i. It’s trading at a discount to NAV of 44%. While the trust is continually updating the value of its private-equity assets until they’re sold, there’s always going to be a question mark over their true worth. It deserves to trade at a discount as a margin of safety against uncertainty, but 10%-20% would be more appropriate. That also goes for other private-equity trusts, such as Pantheon International (LSE: PIN), HgCapital (LSE: HGT), Oakley Capital (LSE: OCI) and ICG Enterprise (LSE: ICGT).
There’s not enough space to cover all the discounted trusts here. However, as this limited selection shows, there’s clear value in the sector.