Investment trusts are trading at knock-down prices, but does that make them a bargain?
- 11 out of 16 sectors trading with a negative Z-score of between 1% and 2%.
- Discounts in the renewable energy infrastructure sector vary between 14% and 55%.
- Investment trusts are still battling cost disclosure problems.
Investment trust discounts are now at their highest level since the darkest days of the financial crisis. Poor sentiment, economic weakness and problems in specific sectors have all contributed to the weakness. Historically, when discounts have been this wide, it has been a compelling buying opportunity, but is true this time round?
Research from AJ Bell shows that all sectors except Japan are trading at a negative five-year Z-score (a negative Z-score shows that the current discount is below average levels), with 11 out of 16 sectors trading with a negative Z-score between 1% and 2%. This has historically been a sweet spot for long-term performance.
The discounts are extreme in a number of sectors. Discounts in the renewable energy infrastructure sector, for example, vary between 14% and 55%, in the UK commercial property sector, they are as high as 69% (and none are below 8%). Renewable energy infrastructure has a negative Z score of 2.8, which looks particularly low.
Along with the commercial property and infrastructure sectors, renewable energy trusts have been hit hard by rising interest rates. These sectors had provided a reliable source of inflation-adjusted income at a time when fixed income yields were at or near zero. They have been hit by flows moving back into fixed income as bond yields have risen.
In theory, this shift should be drawing to a close now interest rates rises are at an end. However, they have been in the vanguard of another problem for the sector: cost disclosure. Wealth managers and multi-managers were major holders of infrastructure, renewable energy trusts, and have been exiting the sector over cost disclosure rules. While there appears to be progress in encouraging the regulator to look again, this may continue to exert a drag.
Laith Khalaf, head of investment analysis at AJ Bell, urges caution for bargain hunters: “Some of the widest discounts appear in trust sectors investing in illiquid assets. Investors need to be particularly cautious about bargain-hunting in the illiquid market, because such wide discounts probably mean the market is expecting write downs in the underlying assets. The proliferation of trusts launched in illiquid sectors over the last decade also partly explains why overall discounts are at their highest level since the financial crisis.”
Many of these trusts haven’t been tested in a higher interest rate environment, so there remains an element of uncertainty. This is true for both infrastructure and renewables, but also private equity and certain property sectors.
While discounts appear to offer investors a considerable margin of safety, there are still reasons to be cautious. Bargains are appearing, and the economic environment is nowhere near as precarious as during the financial crisis, but it may not be a one-way bet.
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