Keiron Root highlights those investment companies best placed to benefit from any further signs of a recovery.

Reports of the demise of the investment companies sector may have been exaggerated. At least
that is the conclusion of the latest monthly investment companies report from WINS Research. Simon Elliott, head of investment companies research at WINS, suggests that ‘From being in the doldrums six months ago, the investment trust sector now appears to be moving back towards rude health. Discounts have tightened substantially and, including alternative asset classes, we estimate that the sector is trading on a nine per cent discount, compared with 19 per cent back in December.’

Looking for yield
He explains, ‘There are two broad reasons for this. Funds that have above-market yields and can offer investors a high degree of dividend certainty, such as those in the UK Income Growth sector, are in strong demand and, consequently, are trading on tight discounts or small premiums. Many funds have made it clear that they will use their substantial revenue reserves to at least maintain their dividends. In addition, alternative funds such as private equity, property and hedge funds have also seen their discounts narrow considerably. In the case of private equity, this is partly because NAVs have fallen, but there has also been a strong rebound in share prices this year.’

Elliott feels that ‘It is too early to call the bottom of the cycle for this sector, but many funds are in much better shape after strategic disposals and the consequent reduction in outstanding commitments. Standard Life Private Equity and Pantheon International both announced disposals last month, albeit at sizeable discounts. With the recent market rise, some commentators have called the nadir for private equity valuations but we suspect this is a little premature. The effect of rising multiples may yet be offset by falling earnings, and currency movements are likely to detract from valuations at the end of June.’

Coping with the risks
At the other end of the scale, Elliott’s team have also been looking at a couple of generalist trusts in recent weeks. Gartmore Global has the benefit of a long-standing fund manager – Brian O’Neill has been running its portfolio for 26 years and Elliott reports that he has ‘a good long-term record through a stockpicking approach, with an asset allocation overlay’.

Elliott concludes that, given the trust’s current level of equity exposure, at 92 per cent, ‘we would not expect this fund to significantly outperform if the market rises strongly. However, the manager has a good track record over a variety of market conditions, and for those who are cautious on global markets, we believe this fund offers an attractive risk-adjusted proposition.’

By contrast, Scottish Mortgage has delivered a more volatile performance record over recent months, but Elliott sees signs of a recovery. Managed by James Anderson of Baillie Gifford, he points out that Scottish Mortgage ‘endured a terrible year in 2008, with the fund’s NAV falling 45 per cent and its share price down 42 per cent. But James Anderson must be given credit for sticking to his guns. After a nightmare year, it would have been easy to have neutralised the gearing and bought defensives. But by not changing the strategy or the underlying portfolio, Scottish Mortgage has provided investors with a chance to recoup some of the lost performance already this year.

‘In addition, the manager remains passionate in his belief regarding long-term global economic trends, including an ever-dominant China. However, for those who can take a long-term view, agree with Anderson’s investment case and can endure higher volatility, we believe that Scottish Mortgage will outperform, particularly in stronger market conditions’.

Star manager delivers
Another name worth keeping an eye on among the generalists is Edinburgh Investment Trust. Its first set of results since the appointment of Invesco Perpetual to manage the funds in September revealed that the trust had achieved its objectives of increasing NAV by more than the growth in the FTSE All-Share Index and delivering an above-average dividend increase.

Scott Dobbie, Edinburgh’s chairman, notes that manager Neil Woodford ‘has constructed
a portfolio of companies that he believes are strongly placed to continue generating satisfactory profits and dividends in an expected weak economy. While income generation is the immediate priority, he does not believe that this need be at the expense of capital growth as the market recovers.’