Market volatility can either be a problem or an opportunity for investors in closed-ended funds, according to Interactive Investors’ Rebecca O’Keeffe, but it all depends on your timing.
While volatility is not a new concept for investors, recent events have served to remind of the buying opportunities that can be thrown up when markets overreact.
The latest market sell-off was sparked by US president Donald Trump’s hostile tweets threatening to impose more tariffs on China, further exacerbating the burgeoning trade war.
This came after a largely market-positive move by the Federal Reserve to cut interest rates after abandoning its normalisation drive last year.
Performance of indices over 1mth
Source: FE Analytics
All of this volatility has been a ‘trader’s dream’, according to head of investments O’Keeffe, and is good for those “who buy individual companies have been relishing the opportunities that choppy markets bring”.
However, for long-term fund and trust investors, it has been a collectively worrying time, with the advice of holding tight during more volatile conditions arrive proving correct, so far.
While such advice might apply to existing investments, for those sitting on some cash, wild swings in market valuations could prove ‘very lucrative’ for trust investors.
O’Keeffe said that the nature of investment trusts and the listing of their shares on the secondary market means that investors can sometimes pick up bargains.
“The fact that investment trusts trade as companies in their own right introduces an extra level of ‘noise’ into their price,” she said. “At turning points in the market, this can lead to a change in their discount to net asset value [NAV] if the price of the trust over or under-reacts to the move in the market.”
What this means is that the volatility can “easily drive discounts to NAV up or down by 5 percentage points or more as it becomes harder for investors to pinpoint precise valuations.”
At the high points a trust can trade an unexpected premium to NAV, according to O’Keeffe, when, if complacent investors continue to bid-up prices.
In market troughs and periods of low sentiment, however, pessimistic investors can often depress trust prices well below the NAV, leading to excessive discounts”, what O’Keeffe said is known as discount risk.
“This discount risk tends to be correlated with how volatile markets are, so a short period of correction will sometimes offer investors a window in which to take advantage,” she explained.
“The danger is that if markets remain erratic for a prolonged period, the discount could widen even further, resulting in losses from both falling NAV and widening discount.”
While the impact of the market sell-off on premiums or discounts were in the order of 2-3 per cent in most cases, “these extra advantage points”
Below, O’Keeffe takes a look at four of its most popular trusts to see what impact Trump’s trade taunts had on their premium/discount.
Source: Interactive Investor
The first is the £8bn, five FE Crown-rated Scottish Mortgage Investment Trust, managed by Baillie Gifford’s James Anderson and Tom Slater.
This was one of the more extreme examples of the impact that volatility can have on discount/premium, as it moved from a 1.4 per cent premium to NAV at the end of June to trade at a discount of 1.4 per cent following Trump’s tweets.
This would have provided an extremely attractive point for the growth-focused trust given that it trades at a 12-month average premium to NAV of 2.1 per cent.
Scottish Mortgage is extremely popular as its high conviction approach to growth investing has paid off for investors in the long run.
Indeed, over the past 10 years the Scottish Mortgage has made a return of 573.03 per cent compared with a 236.53 per cent gain for the FTSE All World benchmark and a 224.29 per cent rise in the IT Global peer group, to 9 August.
Anderson and Slater believe that, over time, share prices will come to reflect a company’s earnings so those that businesses that can grow fast have the potential to deliver superior returns.
Another popular trust with investors that saw its discount widen was the £1.5bn Murray International Trust, overseen by veteran investor Bruce Stout.
Stout’s trust saw its discount widen to 4.7 per cent on 7 August, wider than the 3.5 per cent it recorded at the end of June and significantly wider than its 12-month average of 0.2 per cent.
Source: Factsheet
Over the past decade the Murray International Trust has made a total return of 158.22 per cent, compared with a 220.3 per cent gain for the average IT Global Equity Income peer and a 254.43 per cent rise for the FTSE World index. Stout has overseen the trust since 2004.
Next up is the £3.9bn F&C Investment Trust, a global equity strategy overseen by Paul Niven.
Aiming to deliver long-term capital growth and income, the trust had returned to trading at a premium in recent years.
However, despite trading at a slight discount to NAV of 0.2 per cent on average over the past 12 months, this had swung out to 5.9 per cent on 7 August.
Nevertheless, under Niven the trust has performed strongly under Niven who joined in June 2014, making a 108.07 per cent return against the FTSE All World’s 91.47 per cent.
Finally, the £780m Henderson Smaller Companies Investment Trust saw the traded at the widest discount of the four trusts, swinging out to 12.7 per cent.
The trust’s 12-month average discount stands at 9.6 per cent discount to NAV, widening to 10.6 per cent at the end of June.
The trust has been managed by Neil Hemon since November 2002, during which time it has made a total return of 1,246.45 per cent against a 691.74 per cent gain for the average IT UK Smaller Companies peer.
Although these discounts present an attractive entry point for investors, O’Keeffe admits that volatility may not be the only reason behind their current discounts and that careful research is needed before investing.
“There is no doubt that there are many other factors to look at besides the current premium or discount,” she added. “But investors who like investment trusts and are in it for the long haul may want to consider keeping a close eye on the premiums and discounts when the market becomes more volatile – these downturns could provide a very attractive entry point.”