In mid-March1 the average share price for a UK investment trust was at a 16% discount to its underlying net asset value. It had been 13% at the end of the year and just 2% at the beginning of 2022. That’s not a great development for the shareholders of trusts.
It’s not unusual for discounts to widen when economic recession is pending, after all the discount is an indicator of retail investor sentiment. And as the cost-of-living bites, more investors have had to fall back on reserves (and put off investment for the future) to make ends meet. Others are seeing banking sector uncertainty reignite and geo-political tensions mount, persuading them to keep their cash close or delay deploying for investment. We are sympathetic to the reasoning but as managers of money, with a deeper understanding of the underlying businesses in which we are invested, the prevailing level of discounts feels overdone.
Not all companies are made equal
Looking at the table below, global smaller companies have had the most challenging time. Smaller companies, with more constrained liquidity, tend to suffer in periods of uncertainty but the bigger influence in the global sector is the US component of many indices. This is high, often up to 50%. Within that component, some heavy weight sectors such as Bio tech have come under significant pressure.
UK and European equities have fared relatively better. As a starting point, they began 2023 more attractively valued than their US counterparts. Secondly, the heavier-weighted constituents in these indices are more generally from ‘old economy’ industries, such as banks, miners, autos and other industrials. These types of businesses, with their ‘defensive’ characteristics, have fared better in the uncertain economic environment.
A handful of companies dominate
The top 20 companies in the FTSE 100, dominated by oil, pharmaceutical, banking and mining stocks, were up 16% in 2022. The other 80 companies meanwhile were down 17%. Looking at the overall return it looks like the market was flat, but actually that was just due to averaging out. There is a huge disparity in the performance of the top 20 companies and the rest. That makes getting good performance from active management challenging.
Overall, in 2022, the FTSE All-share Index was one of the best performing indices globally. Towards the latter months of the year particularly, it enjoyed a strong rally. For any active fund manager closing the gap between the performance of that index and their investment trust would be extremely difficult when just a handful of big companies are leading the market direction. Faster growing, smaller companies in the 250 index or small cap investments, which make better sense for long-term investors, are underperforming. A broader range of stocks is important from a diversification perspective also but such a strategy, which spreads risk, is punished from the point of view of returns when market performance is as skewed as in the prevailing environment.
Patience required for medium and small-cap payoff
We are confident that medium and small-cap stocks will start to perform better, but just not yet. For those investors that are able to adopt a longer-term investment horizon, these stocks are very attractively valued at the moment.
On that basis, we’ve been adding to investment companies that have a significant exposure to medium and smaller-sized companies or which are specialists. These cheap, unloved, businesses may not do well in a severe recession but they have good long-term potential. With markets pricing-in an environment 12-months ahead and rate rises now thrown into some doubt, due to the banking sector issues, it’s not possible to be sure that you are getting the timing just right, but we are more confident that we are backing the right businesses.
Specifically, for CT Global Managed Portfolio Trust we have added to Aberforth Smaller Companies Trust, Law Debenture Corporation, Mercantile Investment Trust (mid-250 investment) and Henderson Smaller Companies Investment Trust. Meanwhile we have come out of specialist property where rising yields are affecting asset valuations. We sold out of Supermarket Income REIT and Assura Plc. The latter a healthcare REIT which was not seeing the level of growth (in medical centres) we would like.
