Investment trust bargains: how to find them and where to look in 2025
We explain the tricks of the trade for finding potential discount opportunities, and name investment trusts where analysts think there will be plenty of value in 2025.
29th January 2025 09:22
There are various ways to improve the odds of investment success, including having a diversified portfolio, investing over the long term, and rebalancing a couple of times a year.
Another one is to keep a close eye on valuations and seek out undervalued areas of the market. This approach is not for the faint-hearted, as it carries the risk of catching the proverbial falling knife. However, for those prepared to stomach the risk, buying on the cheap can potentially pay off over the long term.
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Investment trusts, due to their structure, offer investors the opportunity to go shopping in the sales. At the end of 2024, the average investment trust discount stood at around 15%.
Investment trusts have two values: the amount the trust itself is worth (the net asset value or NAV), and its share price. When the share price is lower than the NAV per share, the trust trades at a “discount”. When the share price rises above NAV, it is trading at a “premium”, as you are paying more than the assets are worth.
In this article, we highlight areas of the market and specific trusts where analysts and professional investors are finding value on a discount basis.
But first, we run through some considerations when sizing up discounts.
Always good to pay less, but performance is the biggest driver of returns
While investment trust discounts are an opportunity to buy a basket of investments for less than the sum of their parts, over the long term it is the performance of those underlying investments that has the biggest influence on the overall total shareholder returns. Put simply, if the trust doesn’t perform well, it is likely to consistently have a high discount due to a lack of demand for the shares.
Another important thing to bear in mind with investment trust discounts is that they typically have a greater tendency to converge to their mean discount rather than the value of their underlying investments.
Therefore, it is useful to consider the current discount versus history, and take a view over one, three and five years, for example. It is also worth comparing an investment trust discount with its wider sector.
Bear in mind that some trusts consistently sit in a tight discount range, meaning it is not a “true” bargain, and the discount is merely “normal”.
Also be aware that when it comes to investment trust premiums, it is not usually worth paying over the odds. This is because high premiums do not tend to be sustainable over the long term. When conditions change, such as when investors become more cautious, premiums can fall and turn into a discount. When this happens, shareholder returns are negatively impacted.
Investment trust discounts: how to size up potential bargains
It is important to remember that there will be a reason why a trust is trading on a discount. This could be related to poor investor sentiment towards the region it invests in, or the trust’s investment style being out of favour, or lacklustre short- or long-term performance. Indeed, it could be all those reasons.
As with any investment trading on a cheap valuation, it’s important to avoid being seduced solely by the discount. Instead, consider the prospects for the investment trust going forwards. If those prospects look bleak, then the discount could widen further, so now may not be a good time to buy.
It is a case of taking a view on whether the prospects for the trust will improve, which could then lower the discount.
Timescale is important. Those investing for the long term – five years or longer – will be buying today in the hope that the discount will, over time, reduce towards the value of the underlying investments held in the trust – the NAV.
For such investors it is less of a concern if the discount widens further in the short term, providing that it reduces over a longer period. However, those with shorter timescales who are looking to make a quick buck from a wide discount narrowing will likely be more irritated if the trust gets even cheaper.
In short, discounts can work in investors’ favour, but it is important to think long term and to be patient. If you buy at the right time, resulting in a high discount falling to a low one, or even moving to a premium, the share price return will be boosted.
Investment trust discounts have been at historically wide levels for three years. As a result, discounts have attracted the attention of US activist investor Saba Capital, which holds stakes in 25 investment trusts, according to the analyst Numis.
Saba is attempting to oust the boards of a number of investment trusts and replace them with two directors that it has chosen. Its proposals are being put to a shareholder vote, which will take place in the coming weeks for six of the trusts. One of the trusts, Herald, has already held its vote, with shareholders voting against Saba.
Other tricks of the trade
In some cases, large discounts can be a more permanent feature for trusts due to a lack of investor appetite for shares and a lack of share buybacks from the board.
Trusts with a low profile, or those that invest in a specialist area of the market, can also persistently trade at discounts to NAV. Such trusts tend to fly under the radar of many investors. With demand low, these trusts tend to persistently trade on a discount.
One way to gauge whether an investment trust board is willing to tackle its discount is share buybacks. By reducing the number of shares in circulation, there’s less of an imbalance between supply and demand. In theory, this will reduce the trust’s discount, benefiting its shareholders as the share price will receive a boost as it narrows towards the value of the trust’s underlying investments.
However, share buybacks are no panacea. Buybacks won’t prevent discounts widening if there’s no demand for the shares. Much more important over the long term is the performance of the underlying investments held by the investment trust.
Also be mindful of the fact that some trusts have discount control mechanisms. This is where boards promise to purchase their own shares if the discount exceeds a certain level, such as 10%, in normal market conditions. This can be beneficial for investors as, in theory, the discount will be contained.
Investment trust bargains at the start of 2025
According to Investment Week, the trade publication, around 91% of investment trusts - or 332 out of 365 - ended 2024 trading on a discount.
Therefore, there are plenty of opportunities for investment trust fans.
Analysts highlight three areas in particular: UK smaller companies, renewable energy infrastructure and private equity.
All three areas have been out of favour amid a rising interest rate environment. As UK smaller companies are more volatile than larger companies, this area of the market suffers when investors become more cautious and reduce risk, which played out as interest rates rose.
Moreover, as this part of the market houses companies that are more domestically focused, it has been suffering from poor investor sentiment towards the UK economy.
A potential catalyst for reviving the fortunes of this part of the market could be further declines in interest rates, which are expected in 2025. Lower interest rates could mean investors become less cautious and size up higher-risk areas of the market.
Moreover, investors may reappraise large caps in light of relatively high valuations and weaker fundamentals, diverting capital back into small-cap areas, which have cheaper price tags.
The investment trust structure can work in the favour of smaller-company strategies. This is because a fixed amount of shares are issued under the investment trust structure. As a result, smaller-company trusts are not exposed to the potential liquidity risk facing funds. With funds, managers can, at times, be forced to reduce or sell holdings to meet investor redemptions.
Winterflood, the analyst, highlighted Fidelity Special Values (LSE:FSV), trading on a discount of -8.9% (as of 24 January). Managed by contrarian investor Alex Wright, it invests across the UK equity market but has a bias towards smaller companies. It is one of interactive investor’s Super 60 fund choices.
“Alex Wright’s stewardship of Fidelity Special Values since 2012 has been impressive, reinvigorating the fund’s rationale as an investor in special situations.
“Wright has the benefit of extensive knowledge of the UK small-cap market and is supported by Fidelity’s well-resourced research team. Wright’s contrarian value approach, with a focus on the potential for positive change, offers an attractive proposition, with downside risks reduced by the already relatively low UK valuations.
“The fund has traded at a premium to the peer group for most of the last five years and the board’s commitment to ‘maintain the discount in single digits in normal market conditions’ limits the downside discount risk.”
Winterflood also picked out JPMorgan UK Small Cap Growth & Income (LSE:JUGI). Its discount is -10.9%. Manager Georgina Brittain looks for attractively valued, high-quality companies that have positive momentum.
Winterflood said: “In our opinion, the current discount of -10% offers an attractive entry point, having widened substantially from its tightest level of 2% in mid-August. We see scope for the rating to narrow if sentiment towards UK small caps turns more positive, as we saw for brief periods during 2024.
“If this does come to pass, which could be triggered by a variety of macro factors, we would argue that JPMorgan UK Small Cap Growth & Income is one of the best available methods to take advantage, by virtue of its performance and prevailing pricing.”
Henderson Smaller Companies (LSE:HSL), another of interactive investor’s Super 60 investment ideas, is also trading on a discount, of -13.3%. It is managed by experienced stock picker Neil Hermon. The investment approach is focused on identifying quality-growth companies and holding them over the long term.
The other area where analysts are finding plenty of value opportunities is the renewable energy sector. Such trusts have been out of favour with investors due to the higher level of income investors can obtain through lower-risk assets, with cash and government bonds with short lifespans offering yields of around 5%. Such a backdrop reduces the appeal of trying to obtain higher yields for a higher amount of risk.
However, now that the interest-rate cycle has potentially peaked, this sector could see a significant shift in sentiment if investors are tempted by the big discounts on offer as bond yields fall in value after rates are cut.
In addition, the yields are very high, with the sector average yield standing at 9.8%.
As noted in a recent feature, James Carthew, head of investment company research at QuotedData, points out that investors could pick almost any trust in the renewable energy sector and receive a very high, growing dividend (although of course not guaranteed).
It is also an area that James Calder, chief investment officer at City Asset Management, is looking at. Calder says that the revenue streams from this sector are government-backed and long term, adding: “They have gone out of favour and the share prices have dropped, but they are still generating the same strong cash flows. That means the level of yield has got higher and higher.”
Greencoat UK Wind (LSE:UKW) is popular with interactive investor customers, consistently appearing in our monthly top 10 most-bought investment trust rankings. Its income stream is linked to inflation, meaning that investors should see their dividend growth match rising prices in the economy. Its discount stands at -24.4%, and the dividend yield is 8.3%.
A third area for potential discount opportunities is private equity. It has also been an out-of-favour area over the past couple of years. Investors headed for the door after being spooked by a combination of rising interest rates, fears over valuations and a general “risk-off” mood in markets.
Numis makes the case for a turnaround: “We believe the outlook is positive for share price returns from listed private equity investment companies, fuelled by a combination of a continuation of strong NAV return track records and the potential for narrowing of discount.
“In the long term, we expect NAVs to be driven by the strong earnings growth from portfolio companies, fuelled by managers adding value through active ownership of companies, delivering operational change and having the flexibility to adapt to a changing environment. A more stable, or declining, interest-rate environment would also be supportive.”
Numis highlights the wide discounts of Oakley Capital Investments Ord (LSE:OCI), HarbourVest Global Private Equity (LSE:HVPE) and Pantheon International (LSE:PIN). The respective discounts are: -28.5%, -38.1% and -36.6%.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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