Bargain time for investment trusts

One type of share is stepping back into the sunshine after three years of dark days, says Paul Whitfield. They have fallen so far that discounts begin to look very attractive

The reputation of investment trusts has suffered terribly with poor returns from three years of falling stock markets compounded by association with the collapse of a number of split-capital trusts.

But one old investment adage has it that unloved investments often provide the best opportunities. In the case of investment trusts, this wisdom increasingly resonates.

The extent to which the trusts have fallen out of favour was made clear this month when the Association of Investment Trust Companies (AITC) said sales to private investors for 2002 had fallen 25 per cent to £206m, the lowest level since 1995. But bad news for investment trusts could be good news for investors.

Charles Cade, head of research at brokers Close Wins, says: "Sales have fallen and with that the cost of the shares in trusts has come down significantly." As the trusts' share prices have fallen, the gap between what you can buy them at and the value of their underlying assets has grown. The extent of this gap, known as the discount, is attracting increasing attention.

Mike Neumann, a director of the independent financial adviser (IFA) Bestinvest, says: "Discounts to assets in many trusts have moved to historically wide levels. There does seem excellent value there now."

Like other listed companies, the value of an investment trusts shares will rarely be the same as the value of its assets. This differs from unit trusts, the value of which is a direct arithmetic translation of the value of their investments.

Mr Cade says: "Take the Fidelity European Values and Gartmore European investment trusts: Europe is out of favour with investors and these trusts, which normally trade near their asset value, are at almost a 20 per cent discount."

The hope is that when share prices generally recover these discounts will narrow, handing investors a double boost, on the discount and the rising value of the shares they hold.

But there is nothing to say this has to happen. The AITC says the average investment trust discount for 2002 was 12 per cent. That is almost the same as the average of the previous six years. In 1994, that average was as slim as 6 per cent, but it has been much wider too, a whopping 31 per cent in 1976.

Hilary Cook, director of investment strategies at Barclays Private Clients, says: "You need to identify a reason why the discount will narrow. Without that you might as well ignore them."

Those bullish about a future narrowing of discounts tend to say private investment in trusts is at a low ebb, and when it increases investment trust share prices will rise and discounts narrow. And insurance companies have been forced to sell the trusts' shares to balance their books. When this slows or stops, the bulls say discounts will snap back.

Mr Neumann says: "If, as is likely, the life insurance companies steady their ships at the same time as the stock market finds firm ground discounts could provide a nice bonus." He and Mr Cade like Fidelity European Values Investment Trust, which is trading at an 11 per cent discount, compared to a one-year average of 3.5 per cent.

Mr Cade says: "This trust is almost identical to the Fidelity Europe unit trust, but you are getting it at a discount that I think will narrow." On the downside, it recently changed manager, when the highly respected Anthony Bolton was replaced by the less experienced Tim McCarron. Mr Cade also likes the Gartmore European Investment Trust. He says: "It closely mirrors Gartmore's European Unit Trust. both are managed by Roger Guy, but you can get the investment trust at a discount of more than 12 per cent. It usually trades closer to even."

Mr Nuemann is a fan of the Foreign & Colonial Investment Trust, the UK's biggest, which was trading at a discount of about 13 per cent, against a one-year average of 9 per cent. Jeremy Tigue, F&C's manager since July 1997, told shareholders that "2003 will present opportunities for us to increase gearing and take advantage of some of the forced selling pressure around". But the trust was elevated to the FTSE 100 this month, causing a lot of investment in the fund, forcing its discount to almost half in a few days.

Ms Cook says her firm, Barclays Private Clients, has been watching 3i investment trust. She says: "It is a venture capital company set up as a trust. Its expertise is second to none and it has a massive network of researchers. Even better, it is trading at a discount of about 16.6 per cent against a year's average of just 1 per cent and it often trades at a premium. We think that is excellent value."

Investment trusts can be bought as part of a self-select individual savings account (Isa) the same way as other shares.

'I'm ready to reap the rewards of a turnaround'

Adam Van Dok, 27, is a relative newcomer to investment trusts. "I have been investing for about 18 months so I haven't seen many of the good times, but I am keeping a long-term view. I plan on investing for ten to 15 years," he says.

Mr Van Dok, a London banker, invests £30 a month in the Northern Investors Investment Trust and Edinburgh Smaller Companies investment trust. "I began as a way of saving," he says. "I chose investment trusts because their fees are lower than those of unit trusts."

The value of Mr Van Dok's investments has fallen, but he says he is ready to reap the rewards of a market turnaround. "I am pleased, despite the falls, because the shares I am buying are coming with great discounts, particularly the Edinburgh fund."

For a free guide to investment trusts, call the AITC on 0800 0858520 or speak to an IFA.