UK Edition
It is time to step back a little from discussion of individual investment trusts and, from a vantage point at higher altitude, seek to survey the wider stock market to discover where real value is to be found today.
As it turns out, we don’t need to look too far. Some of the world’s cheapest stocks are to be found right here in Britain. Cheaper still are some of the London market’s smaller companies.
Buy those smaller companies via an investment trust that’s trading at a discount to the value of its holdings and we are entering into serious bargain-basement territory.
A six-letter shorthand to explain such cheapness is Brexit.
Rightly or wrongly, international investors fled for the exits as soon as they heard the result of the 2016 vote and they have not returned. Largely as a consequence, London-listed shares trade, on average, at 10 times their annual earnings.
The figure for global stocks is 17; for American shares it is 20. Now, it can of course be countered that perhaps British shares will remain cheap and so there is nothing to be gained by buying them cheaply.
But this is to disregard the earnings from which shareholders will benefit when judged relative to the initial investment, especially if those earnings are compounded.
This is illustrated most clearly if we look at companies that pay a dividend. For simplicity’s sake we’ll imagine a business that pays all its earnings to shareholders in the form of divis.
Let’s say that it pays a divi of 10p a share and that before the Brexit vote its share price was 100p. It therefore traded at 10 times earnings (10p of earnings paid 10p of dividends). If you put in £100 (100 shares) at the outset and held for five years you would receive £50 in divis (we assume for simplicity that the dividend does not change).
Now let’s imagine that you bought the same share just after the Brexit vote at 80p. If again you invest £100 you get 125 shares, which produce an income of £62.50 over the following five years.
We assume that the price-to-earnings ratio doesn’t change – in other words, London-listed shares stay cheap – so you sell the shares at the price you paid for them.
Crucially, we have assumed that the profitability of the company was not affected by Brexit and that the only impact of Britain’s decision to leave the EU was on the valuation of its shares relative to its profits.
If, therefore, you invest in profitable companies, you should make bigger returns thanks to buying them cheaply – even if they remain just as cheaply valued, relative to profits, when you sell them. This argument applies even more strongly in the case of smaller companies because they have been even more severely out of favour since the Brexit vote and over the long term smaller companies have tended to outperform larger ones.
So if smaller British companies are the place to invest, it makes sense to do so via funds that in effect make them cheaper still: investment trusts that are trading at a discount.
One example is Aberforth Smaller Companies, tipped here in the past.
“I met the managers in June and they said their average holding traded at seven times earnings – and not because of poor earnings,” says Peter Hewitt, who runs the CT Global Managed Portfolio Trust. “Aberforth Smallers trades at a 14pc discount, so the effective p/e ratio if you buy now is six.”
But many other trusts that invest in smaller companies also trade at appreciable discounts. Examples include Montanaro UK Smaller Companies, which yields 4.6pc and trades at a discount of 9.5pc, and the Invesco Perpetual UK (4.4pc, 8.5pc), Henderson (3.4pc, 12.6pc), BlackRock (3.2pc, 13.5pc) and JP Morgan UK (2.6pc, 12.3pc) Smaller Companies trusts and the Diverse Income Trust (5pc, 6.9pc).
Hewitt adds: “I think there’s a strong valuation case here – institutional investors are catching on, private savers not yet. In a year’s time, maybe six months, I think smaller companies will be higher, especially if interest rate falls make the operating environment better.”
All the trusts named above are worth buying; our standout choice would be Aberforth Smaller Companies
Questor says: buy
Ticker: ASL
Share price at close: £12.20
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