Investment trust bargain hunter: Stellar performer on 20% discount

Investor trying to catch flying pound signs

Investment trusts that specialise in hunting for small-sized shares with bags of potential have been trading on big discounts since last June’s Brexit vote.

Sterling weakness and uncertainty over the UK's divorce negotiations with the European Union have deterred investors, and as a result the average UK smaller company trust can be picked up on a discount of 13 per cent.

This is much higher than the discount available for trusts sitting in either the Association of Investment Companies UK All Companies sector (average discount 7.1 per cent) or the UK Equity Income sector (average 5.1 per cent).

But when shopping in the discount aisle care needs to be taken, as some of these smaller company trusts persistently trade on double-digit discounts that fail to shrink. Thus, although a discount may appear high, it could be a case of being a fairly normal level for that trust, rather than a true discrepancy.

Aberdeen Smaller Companies Income’s (ASCI) discount is not rigid, swinging between a range of 17 and 25 per cent over the past year. At present the discount stands at 20 per cent – but although there have been cheaper entry points, investment trust broker Winterflood describe the current discount as ‘offering value’.

Kieran Drake, a research analyst at Winterflood, explains: ‘The fund’s discount is currently around 20 per cent, which is at the wider end of the UK small cap peer group. In June, the differential in discount level between the fund and the peer group reached its highest level in the last five years, and, although it has since narrowed, it still remains significant.’

Managed by Jonathan Allison and Ian Hewett, ASCI invests in ‘quality’ companies. In addition, Winterflood notes that capital protection is at the ‘forefront of the manager’s approach’. There’s also 10 per cent of the portfolio’s net asset value tied up in fixed income, which according to Winterflood ‘offsets the fund’s gearing and boosts its income’.

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Its performance record catches the eye, with ASCI outperforming both its benchmark (FTSE Small Cap ex‐Investment Companies index) and its peer group over the last five years. But given its preference for quality stocks, this is not a trust that will shoot the lights out in rising markets.

Drake thinks there are a couple of compelling reasons why the discount could narrow in the coming months.

He explains: ‘We believe that the 2.8 per cent yield is attractive and the 20 per cent discount offers value, both in absolute terms and also relative to the fund’s small cap peers.

‘Given the relatively small size of the fund, performance is likely to be the key driver of any re-rating, rather than share buybacks. It is also possible that there could be some discount tightening in the lead up to the fund’s next continuation vote, which is due in 2020 and is held every five years.’

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