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We discuss reasons why some products trade higher than their underlying assets

It goes against the grain to pay more for an investment trust than the underlying net assets are actually worth, but sometimes it can make a lot of sense. The most highly rated trusts tend to experience heavy demand and normally trade at a premium to reflect their superior performance.

In some cases the demand is sufficient to lift a whole sector. For example, strong investor appetite for safe sources of income has resulted in many of asset-backed debt, real-estate debt, infrastructure, renewable energy and property trusts trading at persistent premiums to their net asset value (NAV).

Rare and illiquid assets

Ben Conway, senior fund manager at Hawksmoor Fund Managers, says that on the rare occasions when his team considers buying trusts on a premium the most important criterion is that the closed-ended structure is being used appropriately, such as to access an illiquid asset class where permanent capital is most useful.

‘Another important consideration is that the underlying assets in the portfolio are cheap even after taking into account the premium and that they are relatively scarce.’

Hawksmoor recently purchased a holding in BB Healthcare (BBH) at a small premium. The main reason was because the closed-ended structure enables the fund’s highly regarded managers to run a far more concentrated portfolio than the UCITS rules would allow using an open-ended fund.

‘Another trust we have purchased at a premium is GCP Infrastructure (GCP). We like the assets within the trust, which give access to reliable, often government agency-backed inflation-linked revenues, and believe that they are scarce with GCP uniquely placed to source them,’ explains Conway.

It is also worth bearing in mind that investment trusts with infrequent portfolio valuations may trade on a premium to their historic NAV that does not fully reflect the current situation.

Zero discount policy

Ewan Lovett-Turner, director of investment companies research at Numis, says he is wary of buying investment trusts trading on large premiums, which can be vulnerable if sentiment changes towards the fund or asset class.

‘I would be comfortable buying funds on a small premium that operate zero discount control mechanisms that limit the downside of the discount widening, such as Troy Income & Growth (TIGT), Personal Assets (PAT) or Capital Gearing (CGT).’

A lot also depends on the investor’s time frame, because over the long-term the key driver of returns is likely to be the underlying asset performance rather than changes in the premium or discount.

‘I believe that Bluefield Solar Income (BSIF) is attractive on a 4% premium given that it offers investors a yield of 6.6% from a portfolio of UK operational solar farms with revenues supported by government backed subsidies,’ suggests Lovett-Turner.

Champagne Glasses Infront Of Defocused Lights

Solid source of income

Another reliable source of yield is TwentyFour Income (TFIF) that was launched in March 2013 and offers investors access to UK and European asset-backed securities. The trust currently trades on a premium of around 3% with a yield of 6%.

Anthony Leatham, an analyst at Peel Hunt, says he rates the team at TwentyFour Asset Management highly and considers them to be best-placed to navigate the opportunity set across mortgage-backed securities and collateralised loan obligations.

‘Given the importance of differentiated sources of yield in portfolios, the experience of the management team and the triennial option to redeem up to 100% of shareholdings at close to net asset value, it is likely that this trust will continue to trade at a premium.’

The current portfolio has a weighted average credit quality of BBB and is made up predominantly of floating rate instruments that should benefit from a rising interest rate environment. In addition, the euro exposure is hedged back to sterling.

The influence of retail investors

Emma Bird, a research analyst at Winterflood Investment Trusts, says historically it was relatively rare for investment trusts to trade on premiums for any length of time, but this has changed in the years following the global financial crisis and reflects a fundamental shift in the nature of the shareholder base of investment trusts.

‘Self-directed retail investors using platforms to access listed closed-ended funds have grown in importance and appear to be less sensitive to premium ratings. An example is the Lindsell Train Investment Trust (LTI), which has a predominantly retail shareholder base and is currently trading on an excessive premium of around 30%.’

One fund that Winterflood likes is Capital Gearing Trust, which aims to preserve capital over the short run and generate strong risk-adjusted returns over the long-run.

‘Capital Gearing is currently trading on a small premium and we believe discount risk is alleviated by the fund’s zero discount policy, which was implemented in August 2015. It has an impressive record of delivering strong absolute returns with considerably lower volatility than equity markets.’

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