Be careful to ensure trusts offer the right sort of gamble

The word “discount” seems to give the opportunity to get more for less. That’s why there’s a lot of excitement about the widening of discounts on many mutual funds, especially those focused on commercial real estate, private equity and smaller companies.

But scrimpers like me need to know when to curb their instincts. Because while a discount may seem like a cheaper bet on the growth of the trust’s underlying holdings and the flow of dividends, the reality can be much less rewarding.

For example, the Chrysalis trust has a 46 percent discount.

This is the gap between the share price and the net worth of its assets, which are largely owned by technology companies such as Klarna, the Swedish buy-now-pay-later company. The valuation of this company fell from $46.5 billion to $6.7 billion in 2022.

But the stock market’s assessment of Chrysalis also has other causes. The managers’ performance fee, which one critic described as “blatant”, has been cut from 20 percent to 12.5 percent. Still, the surcharge, on top of the annual management fee, still seems excessive, especially when recent returns have been barely stellar.

You might consider Chrysalis attractive, believing that some of its early-stage bets should pay off – though the trust has sold its stake in beleaguered Revolution Beauty for a loss of £40m. Perhaps selling out as a dud can be seen as a positive sign.

But the decision to put money into this or any other trust at a significant discount should be based on confidence that the share price can recover. The managers should also take steps to reduce the discount, rather than relying on a reassessment of the trust’s allure by the markets.

To increase the share price, a trust can buy back its own shares or raise awareness of its offering through marketing. Details of the trust’s discount control mechanism should appear on its website.

The pressure to take action comes against a background of growing dissatisfaction with discounts.

In early December, Peter Spiller, manager of the defensively positioned Capital Gearing Trust – which has a zero discount policy – ​​called on the managers of Abrdn’s Asia Focus and Diversified Income & Growth to reduce the discounts on these trusts, of 9.8 percent and 19.10 percent respectively. .

Diversified Income & Growth, in which Capital Gearing has a small stake, adjusted its discount policy at the end of last month.

But brokers Investec are not convinced and have downgraded confidence from ‘buy’ to ‘hold’.

Could Spiller’s intervention be the start of a wider campaign? Let’s hope so. As James Carthew of QuotedData, the analytics group, has stated, extending rebates will cost investors dearly.

Meanwhile, hoping that managers will face their responsibilities, I’ve scoured a selection of discounted trusts.

Iain Scouller, of the brokers Stifel, argues that discounts on private equity trusts could decrease if there is an increase in bidding activity. This week, broker Peel Hunt reported that the European private equity industry has no less than €270 billion in capital waiting to be invested.

Hg Capital Trust, at a 19 percent discount, backs software companies whose services are increasingly sought after by companies looking to reduce their costs through outsourcing.

The Oakley Capital Investment Trust is discounted by 36 percent, but it offers exposure to the development of cloud computing and e-commerce in Southern Europe, an area the trust’s trustee Steven Tredget says is behind “the digital disruption curve.”

Ben Yearsley, of Shore Capital, has bought into the Digital 9 Infrastructure Trust — discounted 17.83 percent — which is putting money into digital infrastructure investments. He likes the trust’s 6.9 percent dividend yield.

Yearsley adds that generous returns are also available from the Supermarket Income REIT (discounted 11.67 percent) whose portfolio includes Tesco, and Hipgnosis, which owns rights to hits by Blondie, Nile Rodgers, Lindsey Buckingham and others. At 44 percent off, it’s a real bargain, according to Yearsley.

A counterweight to Hipgnosis’ gamble could be the Fidelity Special Value trust, which has a modest 6 percent discount. Darius McDermott, of Fund Caliber, calls this “solid confidence if you believe the UK stock market offers good value.” This is very much my opinion.

McDermott also suggests Devon Equity Management’s European Opportunities Trust, which takes a 13.48 percent cut and invests in growth companies like Novo Nordisk, the diabetes drug specialist. Kepler Trust Intelligence says Alexander Darwall, the manager, has a big stake in the trust and can learn from his mistakes. It’s a mix that I’ll be looking for in 2023.