Three cheap value trusts to consider if growth keeps stumbling

The start of the year has been a tumultuous one for investors in growth stocks, with a number of the largest US tech names plummeting as inflation has shot higher and the expectation of interest rate hikes has increased.

This has impacted the high-growth tech stocks particularly hard as it has affected the discount rate used to calculate present day values from future profits.

Comprised of two components, the risk-free rate (interest rate) and a risk premium (a subjective assessment of the risks to the future cashflow), the higher rates are, the less these future earnings are worth.

Growth stocks tend to have more future profitability reflected in their share prices whereas value stocks tend to price in much lower levels of future earnings.

As such, it may be time to consider adding value strategies, which buy unloved stocks in the hope they can rebound. This has been in vogue since last year, as investors started to price in the end of the pandemic and a return to normality.

Mick Gilligan, head of managed portfolio services at Killik & Co, said one way to help answer this question is to look at the relative valuations of value and growth stocks.

To do this he analysed the price-to-book (P/B) of investment companies, which measures a company’s share price against its tangible net asset value – total assets minus intangible assets and liabilities.

Using MSCI World indices, in September 2020 the gap between the cheap value stocks and expensive growth names hit a 27-year high, he found.

“Just to get back to the average 27-year relative valuation implies value outperforming growth by a further 51%. I’d say this rotation [towards value] has further to run,” Gilligan said.

Using this same metric, some investment trusts look particularly cheap, he said, with a price-to-book value of less than one. This is shown in the table below.

Source: Killik & Co

Within this, Gilligan uses three trusts in his own model portfolios to give balance to his growth names and take advantage of any market rotation towards value.

First is Temple Bar, run by Ian Lance and Nick Purves since 2020. The board switched asset management company when Ninety One’s Alastair Mundy retired, with the pair from Redwheel (formerly RWC) taking charge.

Some investors may have been put off investing in the trust after it ended its multi-decade dividend growth record in the early stages of the pandemic. The board decided that its extreme value portfolio suggested it should focus on reducing the high leverage first, according to Gilligan.

“However, the board subsequently carried out a manager review and, thankfully, stuck to its value position in appointing RWC, an experienced team in this space,” he said.

“This trust has the cheapest portfolio (as measured by P/B) in the entire investment trust universe and the current portfolio provides good exposure to resource stocks (BP, Anglo American, Total) and banks (NatWest, Standard Chartered, Barclays, Citigroup) which tend to do well in a rising commodity, higher interest rate environment.”

Since taking charge, Lance and Purves have delivered an 84.5% return, more than double the FTSE All Share and 34 percentage points ahead of the average IT UK Equity Income peer.

Total return of fund vs sector and benchmark since managers’ start date

Source: FE Analytics

Staying within equities, ScotGems is another that Gilligan uses to back the value trade. The trust holds a portfolio of well-managed, well-financed smaller companies in some of the fastest growing economies in the world.

The trust had a strong 2018 but a disastrous 2019, when it lost 23.2% versus a 5.7% rise for the IT Global Emerging Markets sector and 7.2% gain for the MSCI Emerging Markets Small Cap index. Last year it also made a loss.

But so far in 2022 it is up 5.2%, while the index and average peer are in negative territory and Gilligan said the tide may be turning.

The shares currently trade on a 19% discount to net asset value (NAV). However, he noted that this partly reflects high ongoing costs (1.5%) and a wide bid offer spread (c4-5%).

“So, it’s one to buy a position in and hold tight rather than one for the savings plan,” he said.

“The board and investment manager clearly like the look of the portfolio as their combined shareholding is now 23.8% of the register, having added 650,000 shares during 2021. I think this portfolio has scope to deliver very strong returns over the long term.”

Last up is Utilico Emerging Markets, which invests primarily in infrastructure and utility companies operating in emerging markets, where businesses tend to provide essential services or have monopoly-like market positions.

The trust’s portfolio is typically exposed to sectors such as electricity generation & transmission, water provision & sanitation, telecommunications, and transportation.

“The coronavirus outbreak has had a negative near-term impact on some of the more economically sensitive investments such as ports and logistics,” Gilligan said.

“However, over the long term we expect economies and markets to recover. The shares now trade on an 11% discount and offer an attractive 3.6% dividend yield.”