Falling net asset values and widening discounts in evidence for previously popular funds
Thursday 24 Oct 2019 Author: Steven Frazer

The allure of high growth and often pre-profit companies may be finally losing its hold over investors who are increasingly counting the cost of chasing supposedly ‘hot’ stocks regardless of valuation.

The collapse of the mooted IPO of US property firm WeWork at the end of September underlined a third quarter theme where the valuations of many recent IPOs and previously racy companies, including Uber, Lyft and Slack, have been checked, calling into question the inflated valuations private market valuations of emerging growth companies.

This change in sentiment has impacted investor appetite for the growth-focused equity strategies of many popular investment trusts during the third quarter to 30 September, according to statistics pulled together by analysts at broker Stifel.

Investment trusts exposed substantially to stakes in unlisted pre-IPO companies, and those which have taken on debt have been under particular pressure.

Scottish Mortgage (SMT), which has 22% of its portfolio in unlisted companies, has moved from a 2% premium to net asset value at the beginning of the quarter to a 4% discount and ‘has continued to decline in share price terms post the period end,’ note the Stifel investment trust analysis team.

This has seen the Scottish Mortgage share price fall by nearly 8% since the end of June, to 490.2p.

PREMIUM CONTRACTION AND DISCOUNT EXPANSION

While the sorry saga of Woodford Patient Capital Trust (WPCT) has added to the drag on growth oriented investment trusts over the period (its shares have more than halved since early June), many have come under pressure from NAV declines and contraction in share price premiums, or the widening of discounts to NAV.

The share price of Baillie Gifford US Growth Trust (USA) fell 6.7% during the third quarter as its NAV declined 7%, keeping its modest 2.25% or so premium to NAV roughly intact. At the end of May, the Baillie Gifford US Growth portfolio had 11% invested in unlisted growth companies.

Perhaps most stark is the 25% share price slump of the previously bullet-proof Lindsell Train (LTI), slashing its premium to NAV from a 85% to under 30%.

There are a couple of fundamental reasons for the predominance of growth strategies for most of the past decade. First, economic growth has been modest or worse for much of the developed world since the end of the 2008 financial crisis.

That has meant that investors have been forced to accept more risk to get a return on their money, while companies capable of generating meaningful growth against such a backcloth have become highly prized by virtue of their relative scarcity, with often lofty valuations to match.

The second point boils down to the ready supply of cheap money. With interest rates anchored at or near rock-bottom levels, growth companies have enjoyed access to a sea of easy and cheap strategic capital to raise and deploy, even for many start-ups where a profits breakthrough has proved elusive for longer.

Macro factors, such as the US-China trade war and slowing economic growth, continue to hamper the markets and diminish investor risk appetite.

‘This may be the reason that defensive asset classes are coming more into vogue at the expense of growth-focused funds,’ adds Stifel.

SAFETY IN INFRASTRUCTURE

This helps explain the firm third quarter performances of certain infrastructure trusts, those focused on speciality financing, and other more defensive funds started to show their value.

The infrastructure sector experienced the strongest sector re-rating during the third quarter with its overall premium to NAV rallying two percentage point from 9% to 11%.

Two key contributors were BBGI Sicav (BBGI) and International Public Partnership (INPP). BBGI, whose 6% share price rise saw its premium increase from 15% to 19%, and International Public, whose premium increased from 2% to 5% following a 5% third quarter share price run.

‘Both funds published good interim results during the period,’ report Stifel’s analysts.

Regardless of whether value investing becomes more popular with investors in the future will be of limited interest to core growth investors anyway.

The underlying ethos of Scottish Mortgage, and many growth trusts like it, is to identify and invest in the best growth companies the world has to offer, and hold on to them for at five years, and often far longer.

That’s where they see long-term value and real wealth creation, and that strategy won’t change.

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