Why are ITs at such big discounts?

[funduffer]

Looking at my portfolio of 14 IT's, 13 are at discounts, the highest being GCP Infrastructure at 43%!

I can understand that an IT with high gearing may be more vulnerable to high interest rates, but is this really the only reason, or are IT's really just out of favour?

If out of favour.....maybe a good time to buy!

FD

[daveh]

Looking at my portfolio of 14 IT's, 13 are at discounts, the highest being GCP Infrastructure at 43%!

I can understand that an IT with high gearing may be more vulnerable to high interest rates, but is this really the only reason, or are IT's really just out of favour?

If out of favour.....maybe a good time to buy!

FD

It's an interesting one. I own a couple of green ITs (TRIG and GSF), that I bought when they were at a small premium, for their good dividend. The dividend is now even better as they are at significant discounts, but are still paying the dividend. The question is do I buy more at this time to lock in the good dividend with the possibility of capital appreciation when/ if the discounts close. Do I buy different Green ITs to spread the risk? Or are the high discounts and poor price performance warning of problems down the line?

[88V8]

Looking at my portfolio of 14 IT's, 13 are at discounts, the highest being GCP Infrastructure at 43%!
I can understand that an IT with high gearing may be more vulnerable to high interest rates, but is this really the only reason, or are IT's really just out of favour?
If out of favour.....maybe a good time to buy!
FD

It's an interesting one. I own a couple of green ITs (TRIG and GSF), that I bought when they were at a small premium, for their good dividend. The dividend is now even better as they are at significant discounts, but are still paying the dividend. The question is do I buy more at this time to lock in the good dividend with the possibility of capital appreciation when/ if the discounts close. Do I buy different Green ITs to spread the risk? Or are the high discounts and poor price performance warning of problems down the line?

Infrastructure typically involves a lot of borrowings and anything with a Debt label round its neck is currently out of favour.

Some other trusts hold a good deal of unlisted, where NAVs are a matter of opinion.

Again, some trusts have large holdings in listed companies with high debt.

I think if one digs around, there is generally a reason for discounts.

Presently I'm only buying income ITs majoring in Fixed Interest, and not much of that atm as my funds are mostly going into Prefs.

V8

[Urbandreamer]

There are many reasons for IT's to have a discount.

In the case of the likes of TRIG, who I also own, the following might apply.
Interest rates mean that saving cash may produce similar returns.
The UK government has slapped a windfall tax upon wind farms.
The cost of materials to build new wind farms has gone up.
etc
BTW according to their report, their debt is at fixed interest rates and the level of debt is falling.

With others we could look toward a market malaise and worldwide falling growth projections.
Then there is how unquoted businesses are to be valued. This may explain SMT's discount.

China didn't come out of Covid like a runner from the blocks. This may be effecting the likes of PHI, though they had moved most of their investments to India pre-covid. I understand that they see good opportunities in China now, but the market may not agree.

Personally I would view these discounts as a good investment opportunity, If I had income to invest. Obviously do your own research, but in many cases I regard the discount to be over done and irrational.

[Lootman]

One factor might be that these days there is an ETF for everything these days. And they do not bear the risk of going to a significant discount to net asset value. They are cheaper and there is no stamp duty.

[Dod101]

One factor might be that these days there is an ETF for everything these days. And they do not bear the risk of going to a significant discount to net asset value. They are cheaper and there is no stamp duty.

Personally as an income investor I am mostly happy about big discounts provided I am reasonably confident about the NAV because of course they provide a bigger yield on the share price.

Picking up on an earlier comment about borrowings, debt with a fixed yield is fine in the short term but eventually, like other forms of hedging, they can catch up with the borrower. Airlines can come horribly unstuck and in fact a few years ago did when fuel prices fell very low and airlines which had bought forward on a rising market were left paying very high prices on their contracts.
So high borrowings can be risky and it is one reason to be wary of infrastructure companies.

Dod

[scrumpyjack]

Perhaps there are several reasons:

In a bear market discounts tend to increase as buyers hold off, there is less demand and perhaps people are anticipating further falls in the underlying securities, which would be amplified by the IT's gearing

Where the IT holds unlisted securities, there may be doubt as to their real value and a suspicion that NAV is overstated.

ITs are not usually 'marketed' to the same extent as unit trusts, perhaps because platforms and intermediaries make less money on them

There can also be special reasons, eg Caledonia Investments where the Cayzer family has a very large holding which limits scope for share buy backs.

[Monty]

... I can understand that an IT with high gearing may be more vulnerable to high interest rates, but is this really the only reason, or are IT's really just out of favour? ...
FD

A couple of finance podcasts I've listened to recently have suggested that IT discounts are so large as; UK based pension funds have been big sellers, there is a general malaise about the UK, high interest rates, high inflation making Infrastructure etc unnatractive and if i recall correctly there was also mention that private investors moving into cash and money market funds.

It was thought that foreign predators are circling some of the cheap UK IT's whilst a possible catalyst for closing the discounts was IT mergers to increase their size and become more viable for investment by the large buyers.

The discounts are looking very interesting to me.
Monty

[yyuryyub]

Over 30 years as a private investor, perhaps the biggest lesson I've learned is "respect the market".

It is common to find investment opportunities that look just too good to be true : ITs on massive discounts, companies with net cash that is 70% of market cap. This is published info and the market has looked at it far more carefully than we can. I have found that buying "too good to be true" opportunities has not been a good strategy.

Quite likely, there are some wonderful buying opportunities now. The bigger the discount, the more likely that the real risks are high. But .. yes, at some point there will be bargains, that we will all see with hindsight a few years later.

My own approach has been to drip feed buy a range of different ITs (private equity , property, technology, generalist, small co's), but I've also stocked up on a spread of shortish maturities gilts. So sitting on the fence, a bit.

[DrFfybes]

t is common to find investment opportunities that look just too good to be true : ITs on massive discounts, companies with net cash that is 70% of market cap. This is published info and the market has looked at it far more carefully than we can. I have found that buying "too good to be true" opportunities has not been a good strategy.

Exactly this - same with shares yielding way over market average - the divi might keep rolling in but chances are people who've looked a lot deeper into these things have done the maths too. It isn't always the case, occasionally the Market fails to spot potential (or lack of), but not often.

Somone on here was mentioning Pantheon (PIN) was at circa 50% discount to NAV in summer last year - I had a look and took a punt. It's now back to 35% discount and now there is a tender offer out for a buyback. I'm up over 20%. I don't think I was clever, I didn't do any massive research, I just thought "that's a long way below the average discount" and had a dabble.

I expect there are people out there who's strategy is to buy when Discount to NAV is higher than the long term average, and sell when it returns to 'normal'.

But for a concise answer to the OPs question, how about the first hit on Google

https://www.hl.co.uk/help/funds-shares- ... sset-value

Paul

[mc2fool]

John Baron's article in last week's IC addressed the OP question.

"Poor market sentiment, higher interest and discount rates affecting certain alternative asset classes, and sector-specific issues help to explain why investment trust discounts stand at their widest point since 1990 – apart from a brief moment during the financial crash of 2008-09. There seems to be no end to the bad news. The central question is whether such discounts have become endemic. Omens and experience suggest not. If so, quality companies across a range of asset classes look attractive – many of which offer attractive yields."

The article finishes with a set of "attractive examples" all of which are from the private equity, infrastructure & renewable energy, and specialist lending sectors.

https://www.investorschronicle.co.uk/ideas/2023/10/11/attractive-investment-trusts-despite-the-deluge-of-bad-news/ for those with a subscription.
https://www.google.com/search?q=Attractive+investment+trusts+despite+the+deluge+of+bad+news and click on the IC result for anyone else

Here's a ChatGPT summary of the article for those that can't be bothered to read it (and 'cos I couldn't be bothered to summarise it myself ):

• Investment trust discounts are at their widest point since 1990, driven by poor market sentiment, higher interest rates, and sector-specific issues.
  
• Many investment trust portfolios have underperformed their benchmarks in recent years despite adopting more defensive strategies.
  
• Retail investors are increasingly present in share registers, but they tend to buy in calm markets and sell when conditions are uncertain.
  
• Cost disclosure regulations have caused double-counting of corporate costs, which has led to wealth managers and platform providers avoiding investment companies.
• Positive signs include strong corporate finances, economies avoiding recession, and markets sensing peak interest rates.
  
• Share buybacks are on the rise, increasing demand and confidence in portfolios.
  
• Company boards are taking steps to address challenges through strategic reviews, mergers, and other measures focused on shareholders' interests.
  
• Investment trusts have a strong track record of outperforming unit trusts and indices.
  
• Despite challenges, good quality companies appear appealing as investments, and timing is essential in markets and discounts.

[JohnW]

Some of that doesn’t explain it for me; for example, some have large holdings in companies with high debt. ETF’s or Unit Trusts could also be in the same position but their price closely reflects the NAV of their holdings (I think).
The issue is liquidity, isn’t it? There isn’t enough market liquidity for the price to accurately reflect the assets. If there were no end of buyers and sellers for the IT, then discounted ones would have their prices bid up by buyers seeing a bargain.
It’s a flawed product in that respect, being ‘close ended’.

[mc2fool]

Some of that doesn’t explain it for me; for example, some have large holdings in companies with high debt. ETF’s or Unit Trusts could also be in the same position but their price closely reflects the NAV of their holdings (I think).
The issue is liquidity, isn’t it? There isn’t enough market liquidity for the price to accurately reflect the assets. If there were no end of buyers and sellers for the IT, then discounted ones would have their prices bid up by buyers seeing a bargain.
It’s a flawed product in that respect, being ‘close ended’.

UTs and OEICs don't have discounts/premiums, they trade at NAV by definition.

There may be an issue with liquidity for some of the smallest ITs but hardly so for most of them. The idea of a "bargain" is in the future-looking eyes of the beholder, not a mathematical construct....

[Alaric]

UTs and OEICs don't have discounts/premiums, they trade at NAV by definition..

That can be a problem of itself for some asset classes when the NAV is not easily converted to cash. Recently the M&G Property Fund OIEC announced closure
https://www.investmentweek.co.uk/news/4 ... ad-closure

[scrumpyjack]

Some of that doesn’t explain it for me; for example, some have large holdings in companies with high debt. ETF’s or Unit Trusts could also be in the same position but their price closely reflects the NAV of their holdings (I think).
The issue is liquidity, isn’t it? There isn’t enough market liquidity for the price to accurately reflect the assets. If there were no end of buyers and sellers for the IT, then discounted ones would have their prices bid up by buyers seeing a bargain.
It’s a flawed product in that respect, being ‘close ended’.

I don't think it's 'flawed product'. Being close ended has a lot of advantages - not being a forced seller to meet redemptions, not having high charges to cover all the marketing, being able to retain up to 15% of income to maintain dividend payments through the cycle. Being able to invest in unquoted companies, being able to have modest gearing etc etc.

The discount doesn't matter as long as you don't buy and sell at prices where you lose on the discount change, and a discount means your money is working harder for you as it buys more underlying securities.

One reason is that platforms, like HL, push funds much more heavily than ITs is because they get higher fees from clients who hold funds and similarly unit trusts spend far more on newspaper advertising than ITs do, so, surprise, surprise, the financial journalists push funds rather than ITs.

[JohnW]

Sorry, perhaps it’s more that the trading away from NAV is a flaw in the product, beside any benefits. It’s nice to dividends smoothed out, if that doesn’t cost too much, but the inherent volatility of the underlying assets ie their ‘riskiness’ has added to it the volatility (riskiness) of the discount/premium. That latter sounds like risk without return unless there’s overall more price movement to a premium than there is movement to a discount. Perhaps there is, just not recently. Do we have any long term history to guide us?

[Urbandreamer]

Sorry, perhaps it’s more that the trading away from NAV is a flaw in the product, beside any benefits. It’s nice to dividends smoothed out, if that doesn’t cost too much, but the inherent volatility of the underlying assets ie their ‘riskiness’ has added to it the volatility (riskiness) of the discount/premium. That latter sounds like risk without return unless there’s overall more price movement to a premium than there is movement to a discount. Perhaps there is, just not recently. Do we have any long term history to guide us?

We do have a long term history. After all they have been around far longer than the alternatives.

It would seem that over time IT's do better than funds, though the jury is out as to why. Some claim that it is due to their ability to borrow to invest.
https://www.ftadviser.com/investment-tr ... ar-winner/

Other possibilities are that they CAN invest all their money in illiquid assets. Property funds need to keep a float of cash to handle redemption's during a normal market. Let alone during a property crash. Property funds are "better" and don't have this "flaw" by simply NOT investing!

Some nine out of 15 funds have a cash position above 18%.

https://www.morningstar.co.uk/uk/news/2 ... -2021.aspx

[funduffer]

Thanks for all the discussion in response to my original post.

I have learnt quite a bit from your replies.

In fact, it prompted me to go and read the latest half-year report from GCP Infrastructure (GCP) which is sitting at a 43% discount to NAV.

Yes, their (declared) NAV has fallen a bit.

Yes, they are trying to reduce debt.

But they are also buying back shares, presumably because they believe the share price is much too low and doesn't reflect the true value of the company. This feels like a good sign to me, but who knows?

As for IT's being a flawed product - if they have been around, and largely successful, for >100 years, there can't be much wrong with them!...and a good few have.

FD

[Lootman]

As for IT's being a flawed product - if they have been around, and largely successful, for >100 years, there can't be much wrong with them!...and a good few have.

Not flawed at all. But one can worry about their future. ITs merge or wind up quite regularly. But new issues of ITs tend to be sparse, often restricted to market segments that are in favour, with mixed results.

Because when discounts are the norm, who would issue a new IT? You may lose 10% in the first day of trading.

ITs are almost unique to the UK. America has closed-ended funds which have some similarities but also a few key differences. Ditto Canada.

The size of the IT sector really has not grown, whilst exchange-traded funds have gone from nothing to $3 trillion in 30 years.

The death of ITs has been predicted since I bought my first one in 1986. They are still around of course, but it is not a product that is growing and flourishing. More a specialised and quirky backwater for a subset of investors.

[JohnW]

But they are also buying back shares, presumably because they believe the share price is much too low and doesn't reflect the true value of the company. This feels like a good sign to me, but who knows?

As for IT's being a flawed product - if they have been around, and largely successful, for >100 years, there can't be much wrong with them!...and a good few have.

Buying back shares improves liquidity for sellers but does it bring enough new buyers in to the market to solve the problem being addressed by the buy back? I’ll guess no.
The horse and cart was good for hundreds of years until products more suited to some circumstances came along.
Do we have any history of long term trends of how premium/discounts have been?