Bargain hunter: Cheap trust at widest discount in four years

At a time when Britain's leading blue-chip share index is in uncharted territory - trading close to record highs - it is worth remembering that the art to successful investing is to "buy low" and "sell high", rather than the other way around.

For investment trust fans, the majority of potential bargains have for the past couple of months or so resided in two sectors where, for different reasons, investor sentiment is low - UK smaller companies and Europe.

In both sectors wide discounts remain, particularly in the case of Aberforth Smaller Companies, where shares are trading on close to their biggest discount to net asset value (NAV) since 2013, as the chart below shows.

A year ago the trust's discount was 5%, but it is now available on a discount of 16%, having underperformed its benchmark of late. Over one and three years, the fund's NAV has returned 14% and 13% respectively, underperforming the Numis Smaller Companies (ex IT) index by 6% and 5% respectively.

Sluggish performance

In share price terms the trust's performance is also sluggish, with the ordinary shares up 3.6% over one year and 5.1% over three.

In contrast the average fund in the Association of Investment Companies UK smaller companies sector has posted gains of 14.2% and 22.7% respectively.

Over five years, though, the trust has managed to gain an edge on its competitors, returning 135% versus 129%.

The trust's value approach has failed to pay off over the past three years, but analysts at investment trust broker Stifel predict a change in fortunes may be on the horizon.

They are not the only ones backing a comeback in value investing, which has been in the doldrums for most of the past decade, underperforming the growth style of investing.

One of the reasons why various experts are tipping a renaissance for value investing is the shift in expectations towards better nominal growth, higher levels of inflation and rising bond yields - three ingredients that offer the strategy a tailwind.

Anthony Stern, an analyst at Stifel, makes the point that due to value being in the doldrums, Aberforth Smaller Companies was trading on a historical price/earnings ratio of 10.7 times at the end of November, which represents a 40% discount to the FTSE All-Share index.

Big sector calls

"There are signs that investors may be finally refocusing on value, which could play to the Aberforth style. We like the manager (run on a team approach) and are encouraged that, despite the challenges, they are remaining true to their investment philosophy. We maintain our positive rating."

The trust's biggest sector bet is industrials, comprising 37% of the portfolio versus the 26% benchmark weighting.

Financials are also well-represented, accounting for a quarter of the trust, which works out as a 5% overweight position compared to the Numis Smaller Companies (ex IT) index. Top holdings include bus and rail operator FirstGroup and specialist lender Paragon.

But it has been the trust's big call on the mining sector that has further hurt performance in more recent times, over the past year, notes Stifel. The trust is 'underweight' the sector, which had a strong year in 2016, benefiting in part from the oil price recovery.

The trust is committed to a progressive dividend policy, currently yielding 2.4%Besides seeking to provide capital growth, the trust's managers are also committed to a progressive dividend policy in order to boost the overall total return. The trust's yield is currently 2.4%.

At over £1 billion, this trust is one of the largest members of the UK smaller companies sector, therefore it is relatively easy to trade.

In a recent research note at the end of November, broker Winterflood remarked that Aberforth Smaller Companies has a "decent long-term performance record" and stands out from other funds in its sector due to its value approach.

Winterflood added that "while this has been a drag on recent performance, we believe that Aberforth Partners' experience in value investing should add to performance over the long term".

But Winterflood, despite saying the current discount offers value, particularly as at 16% it is wider than the one-year average of 12%, currently prefers Henderson Smaller Companies, due to its lower fees and a stronger long-term performance record.

In addition, that discount, too, is currently 16%, wider than its one-year average figure of 13.8%.

How we find investment trust bargains

Each month, Money Observer will be highlighting a couple of investment trust bargains, both online and in our monthly magazine.

We will also occasionally draw attention to investment trusts that are "too hot to handle" - those that are trading on big premiums.

Our ideas come from regular conversations with investment trust analysts, and we will try to provide a mixture of bargains, from "hidden gem" trusts with less than £200 million in assets to the more established names that typically trade on a smaller discount or premium.

For the sake of simplicity, rather than using technical measures such as the "Z score", in this column we will identify bargains by comparing current discounts with their 12-month averages.

Only those trusts with a wider discount than their average are considered. We will also look at the overall sector and the quality of the trust, and then take a view on whether the discount looks a good opportunity.

This article was originally published in our sister magazine Money Observer. Click here to subscribe.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.