Annual Investment Trust Review of 2023

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Will Fortune Favour the Brave?

2023 was a year of two ‘halves’ for investment trusts, with the sector in negative territory over the first ten months of the year, before rebounding strongly in November and December, coinciding with increased investor confidence that ‘peak rates’ had been reached. As a result of this ‘Santa rally’, the investment trust sector delivered a positive return of +4.9% for the year, although this still represented an underperformance of the FTSE All Share (+7.9%). This disappointing relative performance was primarily attributable to discount widening, which we think reflects negative investor sentiment towards interest rate sensitive asset classes and a lack of demand from retail investors, who preferred to invest in attractive ‘risk-free’ returns, combined with some sector-specific headwinds such as cost disclosure rules. The sector average discount widened from 11.5% to 13.2% last year, with the nadir of 19% (reached at the end of October) representing a level not seen since the Global Financial Crisis in 2009 and briefly in March 2020 at the onset of the Covid-19 pandemic. Investment trust discounts appear to be closely correlated with UK Gilt yields, particularly since the start of 2022, when inflationary concerns accelerated.

We think this correlation between the investment trust sector average discount and UK Gilt yields is likely to continue in 2024, particularly in rate-sensitive asset classes such as Infrastructure, Renewable Energy Infrastructure, Property and Private Equity. In our view, the current discounts in these areas offer an attractive entry point for 'brave' investors, with the potential for a ‘double whammy’ of improving NAV performance and a positive re-rating when interest rates start to fall, especially if this acts as a catalyst for retail investors to re-enter the investment trust market. Nevertheless, we would caution that interest rates are unlikely to return to near-zero levels any time soon, and therefore the extent of this re-rating may well be limited.

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