Investing just for the thrill of it

Sophisticated players are betting they can squeeze more money by playing the `discount' game
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Investment can mean many things. To a handful of people, investment means taking a gamble, as much for the fun of it as for the prospect of making spectacular returns.

Those who see themselves in this category are among a small number of savers who have been stealthily shifting their money into a range of investment trusts.

They are hoping not just for the returns one might normally expect from equity investments, but to squeeze an extra few per cent by punting on the likelihood that the huge discounts to many funds' net asset value will narrow substantially in the next few months.

The central premise of the strategy is useful for anyone considering how to obtain best value from their savings. The most important thing to understand is the concept of net asset value.

Investment trusts are closed-end funds. A trust is a company, with its own shares which you buy if you want to invest or sell if you are cashing in. The value of these shares is determined by a combination of their underlying assets - net asset value, or NAV - and investor sentiment about the trust itself. A trust can have, say, pounds 100m of equities in a range of blue-chip companies, but only be worth pounds 90m. When this happens, the investment trust is trading at a discount to NAV.

As our graph shows below, since December 1992 the discount has narrowed and then widened again, from 12 to 5 per cent and back up to 12 per cent at present. In effect, the investment trust industry now has more than pounds 60bn of assets under management, but the market capitalisation of investment trusts, what they are actually worth, is about pounds 47bn.

To some observers, this widening of the discount has been a source of worry: investors in this sector are doing worse than if they had placed their money into unit trusts, for example.

Ernest Fenton, director general at the Association of Investment Trust Companies (AITC), says: "No other investment product offers the opportunity of buying shares so cheaply. For every 88p invested you are acquiring assets of pounds 1."

It is this disparity that offers the potential for investors to make some gains by going against the grain of current investment sentiment.

Robbie Robertson, an investment trust analyst at Kleinwort Benson, says: "With investment trusts, you have to be prepared to be something of a contrarian."

He argues it may be time to enter the market, judiciously, and take advantage of discounts narrowing again in future, "gearing up" on the investment.

If you were planning to invest in, for instance, a Far Eastern unit trust, it may now make sense to look at the same sector but with an investment trust. Emerging markets are another area where discounts to NAV are high and it may be worthwhile committing oneself.

So far so good. But the speculative potential does not end here. One of the features of last week's restructuring of the Fleming Far Eastern Trust, discussed in this column, was the degree to which it was prompted by an external "raider", Elliott Associates. This was a US speculative fund which had the potential to cause trouble by pushing for the assets in the investment trust to be sold off. It may be worth looking at the activities of Andrew Schectel, whose US firm, Sierra Trading, is active in the market.

How does he pick investment trusts likely to face similar attentions in future? Charles Cade, an analyst at Merrill Lynch, suggests the first thing to look for is evidence of corporate activity generally.

For example, many trusts hold regular votes, on average between three and five years, by shareholders on whether to wind themselves up. If the discount to NAV is at least 12-15 per cent, investors would receive a decent return even after wind-up costs.

However, Mr Cade warns: "Govett's US Smaller Situations investment trust shareholders, who had such a vote last year, voted to continue."

Carolyn Coke, another analyst at NatWest Securities, agrees that despite a very wide discount to NAV, which at one point reached 18 per cent, Govett's shareholders remained remarkably loyal.

One fund where a wind-up vote will shortly be taking place is the Edinburgh Dragon Trust, again specialising in the Far East. This trust, whose shareholders vote in November, is trading at a NAV discount of 13 per cent.

What about other trusts where interesting corporate activity is nigh, or has already been taking place?

One fund which may have seen the activities of a raiding party is Govett Oriental, in the Far East including Japan sector. The fund, which has operated at a discount to NAV of up to 17 per cent, closed to a 12.8 discount. Kleinwort Overseas, in the international capital growth sector, is another fund to watch, Ms Coke suggests.

But she warns that speculation on this level is only suitable for sophisticated investors: "Some of the arbitrageurs are prepared to take a position many months ahead. They will also have hedged their funds, so that they are not forced to sustain heavy losses if the value of a fund were to fall."

Ultimately, Mr Cade argues, the purpose of investing must be to obtain good value. While investment trusts are ripe for a rebound on their NAVs, hoping to force the pace at a time of uncertain stock markets means risking a lot.

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