Bargain hunter: Three 'cheap' trusts on wide discounts

On the whole, smaller company investment trusts have recovered their poise since being initially rocked by the outcome of last year's referendum vote. In the first six months of 2016, widening discounts turned an average 8% fall in their net asset values (NAV) per share into an average 17% fall in share prices.

The Brexit vote hit the sector hard, with money flowing out of domestically orientated stocks, on the assumption that these types of businesses would be more vulnerable to an economic slowdown.

This, however, has so far failed to materialise, although there are some signs that the second half of 2017 will become a more testing time for the economy.

As things have turned out, those savvy investors who entered the smaller company trust sector in the post-Brexit panic will today be patting themselves on the back, as the average trust has posted a NAV increase of 29.8% over the past year.

But in certain cases share price returns have failed to keep up with NAV performance, which is an indication that investors have remained cautious and have not been piling into the sector.

Indeed, given that the Brexit negotiations have only just commenced, investor caution towards the sector is understandable, and as a result UK domestic stocks look relatively cheap in terms of valuations.

For investment trust fans with a long-term mindset, however, there are bargains aplenty to take advantage of across the UK smaller company trust sector. As previously tipped in this column, Woodford Patient Capital's current 7.9% discount still catches the eye, but there are two other trusts that are potentially bigger bargains at this juncture.

Research by stockbroker Stifel looked at how investment trust discounts today compare with their six-month averages, in order to size up value in the discount. The table below highlights the 10 'widest discounts' on this metric; as it shows, there are two smaller company specialist trusts that are ranked higher than Woodford Patient Capital – Herald and Invesco Perpetual UK Smaller Companies.

Herald, which specialises in companies investing in technology, media and communications, is on a 21% discount, compared with a six-month range between 22 and 17%, while Invesco Perpetual UK Smaller Companies is offering a 7% discount, which is towards the high end of its six-month range of 8 to 2%.

In the case of Woodford Patient Capital, the 7.9% discount, compared to a six-month range between 10 and 1%, is a reflection of "relatively weak NAV performance since IPO", according to Stifel.

On the whole Woodford investors are keeping the faith, however. They include stockbroker Killik, who in a note to clients this week reaffirmed its commitment. "There continue to be signs of significant progress being made from many of the underlying holdings and therefore we continue to view the long-term return prospects for this portfolio as compelling," the firm said.

Why small is beautiful

One of the most powerful long-term investment trends is the outperformance of small shares versus large.

Over the past 60 years smaller companies have shone. Research in 2015 by the London Business School found that investing £1 in 1955 in the Numis 1000 index, composed of the smallest UK-listed companies, would have produced £12,144 by the end of 2015.

The same £1 invested in the FTSE All-Share would have grown to just £829.

Over 10-year periods since 1955, smaller firms outperformed larger companies five times out of six.

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.