Closed-ended funds, in general, had an excellent 2013 as investors felt more comfortable in taking on higher amounts of risk. However, this has meant that discounts have narrowed across the board, leading some analysts – such as Cantor’s Monica Tepes – to say it could be a sign that a correction is due in the market.
Curling agrees that investing in closed-ended funds now carries more risk than it has done in the past.
“To be honest, the sector as a whole is looking very expensive, especially in terms of historic standards,” he said.
However, the manager is bullish on the UK and other developed markets and as a result says that investors can afford to dip down into the more specialised investment trust sectors for discount value.
He highlights three of the closed-ended funds he has been buying for his portfolio.
Ecofin Power & Water Opportunities
Although Curling admits that investing in the Ecofin Water & Power Opportunities trust is high risk because of its specialist nature, he says that its attractive discount and above-average yield mean that it could be a good entry point for opportunistic investors.
“There are a few companies that look interesting, one of which is the Ecofin Water & Power Opportunities,” he said.
“It has no controlling stake, which is a good start, it is trading on a 28 per cent discount and has a yield of 5 per cent.”
“It is highly geared and there are different layers of debt, but it seems when it is restructured and all the zeros are paid over the coming years, then there is a really good chance it will be more in favour.”
“I think that a 28 per cent discount to NAV cushion is helpful as well, though that could be famous last words. The question is whether or not it will lose value over that time, as it is invested in utilities.”
The Ecofin trust, which invests in natural resources companies, has had a difficult time of late. Last year was a particularly volatile one for the trust, as the graph below shows.
Performance of trust vs sector in 2013
Source: FE Analytics
Its largest holding, at more than 11 per cent of assets, is the US-based oil and gas exploration and production company Lonestar Resources. FTSE 100-listed National Grid is its second largest position.
As Curling mentioned, the closed-ended fund is highly leveraged, with gearing of 51 per cent.
Ecofin Power & Water Opportunities has an annual management charge of 1.5 per cent.
Electra Private Equity
Curling is bullish on the outlook for developed markets, especially the UK.
As a result, he finds it strange that private equity trusts are, on general, still trading on relatively wide discounts, as he expects them to move back into favour as the recovery sets in.
“You would have to think that with an improving economy, a pick-up in industrial activity, M&A and IPOs, that private equity trusts would perform well and that their discounts would narrow further,” he said.
“To be honest, I don’t know when that will happen, but I would expect the funds that are getting more mature – the ones with upcoming disposals and realisations – to outperform when it does.”
“My preference is to stick with the managers who have a good long-term track record. The likes of Electra and HG Capital spring to mind,” he added.
Electra Private Equity is one of the most highly rated private equity trusts and the majority of its assets are located in the UK.
The closed-ended fund, which has a market cap of £788m, is trading on a narrower discount than other trusts in the IT Private Equity sector.
It is still trading at an NAV of 15 per cent, however, and it has been one of the sector's best performing portfolios over five years, with returns of 274.38 per cent. As a point of comparison, the FTSE All Share has returned 111.34 per cent over this time.
Performance of trust vs sector and index over 5yrs
Source: FE Analytics
It has a total expense ratio (TER) of 2.75 per cent.
The manager says he is also looking into investing in some of the private equity trusts that are trading on much wider discounts. Some of the cheapest trusts in the sector in terms of discount to NAV include Aberdeen Private Equity (26 per cent), HarbourVest Global Private Equity (26 per cent) and JP Morgan Private Equity (29 per cent).
Henderson Smaller Companies
Although Curling says that more specialised sectors currently offer the best value for money, he says it is still possible to find the occasional bargain in more mainstream areas. He highlights the Henderson UK Smaller Companies trust, his largest holding, as a good example.
“I am very reluctant to ever pay a premium if I don’t have to, as share issuance can reverse it very quickly,” he said.
“Our largest holding, which is Neil Hermon’s Henderson UK Smaller Companies trust, seems to me to be a good opportunity as compared with other excellent managers in the sector. BlackRock is on a 3 per cent discount, so at 12 per cent it seems very good value.”
Henderson UK Smaller Companies is on a discount of 12.53 per cent compared with 3.94 per cent from BlackRock Smaller Companies, 3.3 per cent for Dunedin Smaller Companies and a 1.1 per cent premium for Standard Life Smaller Companies.
It is the third best-performing trust in the IT UK Smaller Companies sector over 10 years with returns of 392.54 per cent and has beaten its benchmark – the Numis Smaller Companies ex IT index – by close to 150 percentage points.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
Henderson Smaller Companies Investment trust is 9 per cent geared and has ongoing charges – including a performance fee – of 1.09 per cent.
