Whether or not you are a value investor by nature, we all get a kick out of finding companies which are trading on big discounts to ‘fair value’.

Rather like Warren Buffett, who claims he buys dollar stocks for 50 cents, we all like to think we can spot a bargain.

The problem is identifying fair value, first, then having the courage of our convictions to go for it, second.

In the investment trust world, however, the first part is done for you.

NET ASSET AND ‘THE DISCOUNT’

The ‘fair value’ of an investment trust is its net asset value or NAV, which is calculated by adding up the value of its investments and subtracting any debt (don’t forget, most investment trusts use a certain amount of debt or ‘gearing’ as they call it to increase their returns).

When you divide the NAV by the number of shares, obviously you get the net asset value per share which you can easily compare with the current share price.

Depending on the level of demand for its shares, an investment trust can either trade at a premium to its NAV, level with its NAV or at a discount to NAV.

In most cases, if a trust continues to trade at a big discount for an extended period of time, the managers can buy back its shares using surplus cash.

Once those shares have been cancelled, reducing the number of total shares in issue, in theory the remaining shares should be more valuable and the discount to NAV should decrease.

HOW DO I FIND OUT THE DISCOUNT?

The best place to look for information on investment trusts is the AIC (Association of Investment Companies) website.

At the moment, the average discount to NAV across the hundreds of companies on the AIC database is 12.5% meaning the average investment trust is trading at 87.5% of its ‘fair value’.

However, the average is made up of a huge range stretching from discounts of as much as 70% or 80% all the way to companies which are trading at a premium of 50% or more.

Intriguingly, even companies in the same sector can trade at vastly different discounts or premiums to their net asset value.

Take the leasing sector, where Doric Nimrod Air Three (DNA3) is trading at 52p per share against a last known net asset value of 27.7p per share or in other words a premium of 87.7% to NAV.

At the same time, DP Aircraft 1 (DPA) is trading at 6 cents per share against a net asset value of 19 cents per share or a discount of 69% to NAV.

There is clearly plenty of demand for the former, and little if any demand for the latter.

WHAT OTHER TRUSTS HAVE BIG DISCOUNTS?

We decided to screen the AIC universe for trusts trading at a 40% discount to their NAV, or in other words at 60% of their ‘fair value’, to see if we could find any genuine bargains.

Our simple screen turned up 10 fairly mainstream funds, a few of them with more than £1 billion on assets and one or two which form part of the FTSE 250 index. We aren’t talking tiddlers here.

Given the sharp rise in UK interest rates, it is no surprise that UK property companies have seen their valuations tumble as property, like any long-duration asset, is negatively affected by a rise in what is known as the risk-free rate or the yield on government bonds.

However, it is hard to see why warehouse investor Tritax Eurobox (BOXE), which as its name implies operates solely in Europe, should be trading at just over half its net asset value when the ECB (European Central Bank) has only raised its key interest rate from 3% to 3.75% this year.

When Shares spoke a fortnight ago with chief executive Phil Redding, a 25-year veteran of the logistics market, he struggled to recall a more supportive environment than the current market where vacancy rates are just 2% and like-for-like rents are increasing by more than 5%.

While the value of the portfolio may have dropped due to the rise in interest rates, strong demand means more rental income which means more earnings and dividends for investors.

‘The occupational market shows attractive demand and supply dynamics, reinforcing our belief in the long-term structural drivers and compelling opportunities in the logistics market’ says Redding.

Another stock where the investment community’s perception and economic reality seem to be fundamentally at odds is private equity firm HarbourVest Global Private Equity (HVPE), which trades at more than a 44% discount to its net asset value.

Arguably, the company’s NAV has proved more resilient than might have been expected in the last 12 months, losing just 1.2% compared with a 7.3% decline in the FTSE All-World Total Return Index, thanks to its strategic mix of infrastructure, credit and small-and mid-cap buyouts.

As analysts at Peel Hunt point out, on top of its attractive mix of assets, which includes a large weighting in the US technology sector, at the end of April the firm had net cash of $313 million and $600 million in additional liquidity giving it $913 million of firepower.

NOT ROCKET SCIENCE

Where we – and we sense, most retail investors – are less clear on the potential hidden value behind large discounts is in ‘new’ markets like space investment and music royalties.

Having burst onto the scene just under two years ago in an oversubscribed £180 million IPO (initial public offering), Seraphim Space Investment Trust (SSIT) – whose strapline is ‘turning science fiction into science fact’ – is the world’s first listed space technology fund.

The trust argues there is a multi-decade growth opportunity in space-related technology, and it has already sent 10 payloads from five of its portfolio companies into low-Earth orbit courtesy of
SpaceX while another of its portfolio companies has signed a €26 million contract with the European Space Agency.

Yet, despite targeting a 20% annual return over the long term, the trust’s shares have instead spiraled earthwards from their 100p listing price to just 37p as investors struggle to get their heads around when if ever the trust will start to earn any money from its investments.

So, while on the face of it the trust is trading at just over 40% of its net asset value, the issue appears to be lack of earnings as well as doubts over valuation.

It is a similar story at Blackstone-backed music royalty firm Hipgnosis Songs Fund (SONG), which trades at roughly half its last reported net asset value.

While the concept of song royalties may be simpler to understand than whizzy space tech, the fund has an insatiable appetite for capital – it has raised almost £1.3 billion in equity since listing in July 2018 – which simply hasn’t been matched by its returns.

Shareholders have been repeatedly diluted by new issues of stock to fund headline-grabbing deals like the purchase of Justin Bieber’s music publishing rights and 290-song back catalogue for a reputed $200 million.

Competition for music rights from the likes of the media arm of Japan’s Sony (6758:TYO) – which reportedly stumped up half a billion dollars for Bruce Springsteen’s back catalogue – means the economics of the business are becoming progressively less attractive.

Unlike Seraphim, Hipgnosis has a share buyback plan in operation to reduce the discount to NAV, but mysteriously purchases stopped last December after just two million of its 1.22 billion shares were purchased, a long way short of its authority to buy back up to 14.99% of the capital.

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