Navigating the investment trust sector to gain long-term growth

Haydn Taylor, managing director of Ravenscroft, UUֱ Picture: ANDY LE GRESLEY

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While this area continues to face challenges, there are opportunities for long-term investors, as Haydn Taylor, managing director of Ravenscroft, UUֱ, says

GLOBAL equity markets have strengthened over the past three months with the UK at last helping lead the way.

However, a recovery is slow to emerge in the investment trust sector, which is arguably overdue a period of rehabilitation. The average sector discount to net asset value remains over 14%, which is wide by historical standards, but below the peak average discount reached last year of 19%. The sector makes up a large proportion of the FTSE-250 index and is one of the reasons for the relative underperformance of this “UK-orientated” index.

The investment trust sector has struggled in the recent past, primarily because of the interest-rate environment and the effect that has had on bond yields to which alternative income assets are correlated, but also because of the current cost disclosure issue which makes institutions and wealth managers report investment trusts’ costs as their own, making their product charges look comparatively more expensive.

The impact of this on investment trust share prices and sentiment has been harsh. However, it has been said that improvements in cost disclosure to level the playing field with open-ended funds could help investment trust share prices to climb. It is widely agreed that the interest-rate hiking cycle in the UK has now come to an end and it is expected that the Bank of England will begin cutting bank rates in the second half of the year, which could prove positive for investment trusts as many are held for income. As yields begin to normalise, discounts should begin to narrow.

For now, investors are somewhat confounded to see wide discounts remain given that NAV performance has been relatively stable. Infrastructure trusts and the renewable energy sector in particular have been some of the biggest victims of the stretched discounts. These alternative real asset trusts are often used to diversify an investor’s portfolio by introducing tangible and traditionally defensive assets that generate a healthy inflation-protected income which is then returned to shareholders.

Investment trust expert Peter Spiller, who has run the Capital Gearing Trust since 1982, was last week quoted as saying: “These discounts cannot be explained by investor concerns that the net asset values of these companies are overstated – our major holdings reported extensive sales of assets at or above book value”.

The sector has also made a significant contribution to the all-important energy transition and the largest such fund, the £3.2bn Greencoat UK Wind, now powers the equivalent of 2.3 million homes with 100% renewable energy. Today, renewable energy sources make up a significant proportion of the electricity that powers our homes and businesses. In 2020, for the first time in the UK’s history, electricity generation came predominantly from renewable energy, with 43% of the country’s power coming from a mix of wind, solar, bioenergy and hydroelectric sources. Since then, renewable energy has remained the UK’s dominant source of electricity generation today, with 41% of power coming from these sources in 2023.

Investors need to be aware that some trusts may employ excessive gearing or fail to cover their dividends with operational cash generation. However, for longer-term investors, the generally wide discounts and high dividend yields of the sector could present a compelling opportunity to benefit from enhanced real income and the potential for long-term capital appreciation.

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