Why 2025 could be the year of opportunity for investment trusts: The INVESTMENT ANALYST

Investment trusts offer a world of opportunities to tap into but how can investors sort the wheat from the chaff? In our new Investment Analyst column, experts run the rule over what’s on offer.

In this column, Thomas McMahon, Head of Investment Companies Research, at Kepler Partners, looks at what 2025 holds for investment trust investors.

It might be a tough period for investment trust managers, with funds winding up and fees under pressure, but it’s a great time for investors in the sector. The reason emerges when you start to look the top performers in 2024.

We all know it’s been a good year for US large cap tech. Nvidia is on a cloud of its own with returns of c. 170 per cent in 2024 at the time of writing. Amazon is up 55 per cent, Apple is up 35 per cent, Microsoft 21 per cent. 

In the investment trust sector, on the much-maligned London Stock Exchange, nobody has quite managed to keep up with the mighty Nvidia, but plenty of companies produced similar or better returns to the other tech giants. 

Some of the best performers are heavily into technology, of which more later, but others could hardly be more different.

Consider Baring Emerging EMEA Opportunities (BEMO), for example. The trust invests in some improbable region that sounds like it was invented by an investment banker in the pub – the emerging Europe, the Middle East and Africa, which means in practice Saudi Arabia, South Africa and various countries across eastern Europe and the gulf which don’t have much in common beyond not being in Asia or America. 

This may not sound as exciting as an app that can make a musical skit starring Vladimir Putin and Diego Maradona in 90 seconds, but at the time of writing, BEMO’s shares are up 37 per cent over 12 months, so investors would have done as well as Apple shareholders and better than Microsoft owners. 

Or consider PRS REIT, which builds and manages rental properties. The shares are up 36 per cent over the same period, delivering a better return than the inventor of the browser you use to download Chrome.

Both of these examples illustrate the effect of closing discounts on shareholder returns, which has helped make 2024 a good year for investors in the sector. And I think 2025 is shaping up to be at least as good, thanks to the discounts still on offer, and pressures on board to tackle them, not least from the widespread activism by professional investors.

Both BEMO and PRS have seen their share prices boosted by a narrowing discount. By that I mean the difference between the value of the assets they own and the value of their shares. When a share is trading on a discount of 20 per cent, that means you are effectively paying 80p to own 100p of assets. 

One feature of discounts that many people miss is that a 20 per cent discount narrowing to zero per cent delivers a 25 per cent return, not 20 per cent: 20p is 25 per cent of your starting price of 80p. Buy on an even wider discount of 30 per cent, and if the shares return to par, you make 43 per cent.

Were you to find something trading on a 50 per cent discount and it traded back to par, you would have received a return of 100 per cent. All these figures assume the net asset value is stable, of course, and it could move either way.

Shares trading on wide discounts are therefore good news for potential investors, although it may be bad news for managers and boards. If trusts are trading on a wide discount in sector X, then there is little chance of listing a new trust investing in X – why wouldn’t investors just buy the rivals at a discount? 

Plus, the pressure builds on both the board and the manager to do something to narrow the discount, which can result in lower fees being agreed and opportunities to redeem shares close to par in tender offers. 

It can even result in winding up the trust and the assets being sold and amounts close to NAV realised by investors. All of this reduces the fees earned by managers, but boosts shareholder returns.

In the case of BEMO, the narrowing discount seems to reflect bargain hunters aiming to take advantage of a NAV which was starting to perform well and a discount which had become excessive – it was close to 30 per cent a year ago. 

In the case of PRS REIT, large investors took an activist approach and forced the board to conduct a strategic review. This has seen the shares rally fast even though the property market has remained sluggish at best. 

Even after such a strong year, BEMO’s shares still trade on a 17 per cent discount and PRS REIT’s at 20 per cent.

We have seen some discounts close entirely. The shares of Baillie Gifford US Growth Trust have delivered an astonishing 67 per cent over 2024 and the shares now trade on a small premium. Most of this has happened since the US election: USA’s shares are up 30 per cent since 04/11. 

In general US-focussed trusts have had a decent boost as market optimism grows, with JPMorgan American up 38 per cent over one year, at the time of writing. 

Trusts with exposure to Elon Musk’s companies have done particularly well, thanks to his close relationship to Trump – namely Baillie Gifford-managed Baillie Gifford US Growth, Edinburgh Worldwide and Schiehallion, all of which have exposure to SpaceX, which is next to impossible for the UK retail investor to access otherwise.

Another factor, however, might be buying by activist investor Saba Capital, of US hedge fund manager Boaz Weinstein. Certainly, Saba wants to claim credit for narrowing the discounts on USA and six others. 

Saba’s plan seems to be to take control of the trusts, offer shareholders a cash exit and then roll over the remaining funds into a fund it will manage that will take out other discounted trusts. 

It has stepped up its buying in recent weeks but it is at least a remarkable coincidence that the discounts have come in the most on USA and EWI, the two trusts with big holdings in SpaceX, and immediately after the US election.

Maybe Saba Capital’s buying has been responsible for the shares coming in? Or maybe they were a bit late to the party and jumped on board as things were already looking up? From an investor’s point of view it doesn’t matter, really. 

If you have made a 67 per cent gain in your Baillie Gifford US Growth shares year-to-date, and the possible outcomes are staying invested or having your cash returned to you, you should really be taking that as a win.

The table below shows the 20 best 1yr shareholder returns on investment trusts as of 18/12/2024. It’s a motley crew, really, with all sorts of niche strategies about which it is hard to draw too many over-arching conclusions. 

Petershill Partners and Seraphim Space have both been boosted by discounts coming in from 50 per cent or more. In general though, you have to be careful with the very widest discounts which can often indicate some structural or corporate governance issues which might get in the way of value being realised – sometimes in life it’s better to be lucky than good.

All this rear-view mirror analysis leads naturally to the more important question about where the value is now. Discounts on average are more or less where they were at the start of the year, with plenty of trusts yet to move. Where are these discounts the most attractive and the chances highest of doing well over the next few years?

Discounts are widest on alternative asset trusts like private equity and infrastructure, but these can be the hardest to understand, can have complicated leverage situations and have uncertainty around the valuation of their assets (which are private and therefore don’t have a market price). 

The widest discounts here are generally on those portfolios with the lowest quality assets or those with assets in construction. It may well be that great shareholder returns come from some of the smaller ones being taken out by larger investors, but equally many of these may languish on discounts for some time. 

Probably a better place to look for bargains, for those who don’t want to become experts on the economics of solar farms or toll roads, is the equity sectors. Here I think the technology trusts all being on double digit discounts is noteworthy. 

If AI products start to emerge next year and/or the developed world escapes recession, it is feasible that the tech sector does well again, and it makes little sense for a portfolio of liquid US tech shares to trade at 90p in the pound if the reality of AI is anything near the promise.

Looking at more niche areas, there are two Vietnam trusts trading on wide discounts: Vietnam Enterprise, which has performed better and is on a 23 per cent discount, and Vietnam Opportunity, which has lagged and is trading on a 26 per cent discount. Both are pretty large trusts, and Vietnam may remain out of favour, so there is certainly scope for the discounts to persist. 

But the growth prospects for the country look interesting and as we have seen over 2024, wide discounts can lead to pressure on boards and managers to take action to close them. 

On that note, JPMorgan Indian and abrdn New India have struggled over the medium term, and trade on discounts of 17-18 per cent. It is hard to see discounts this wide being tolerated for ever, while India remains an interesting growth story.

Perhaps the obvious sector to look for value is the boring old UK trusts. UK mid and small cap trusts are trading on double digit discounts. There are a whole host of UK small cap investment trusts run by high quality managers that are on 12-14 per cent discounts right now, and indeed too many to list. (The widest discounts in the sector are on more niche strategies, many of which are illiquid.) 

Mid-cap funds Schroder UK Mid Cap and Mercantile are on 9-11 per cent discounts too. Boards on these trusts are likely to be keenly aware of the pressure to see discounts close and open to action if they persist. Meanwhile, the UK has been knocked by poor sentiment after the budget, but has some of the most dynamic companies in the world.

For investors who don’t want to research individual trusts, there are two trusts which invest in other discounted trusts: MIGO Opportunities and AVI Global trust, which might be worth considering. And maybe soon we will have a new fund from Saba to add to the list, whether it be a trust or an ETF, like the product they already manage in the US.

In any case, 2025 is unlikely to be boring, and I expect good money will be made by many in the investment trusts sector. Merry Christmas to all readers and I hope you are among them.

All data as at 17 December