A merger and frenzy among investment trusts is likely to be one result as the "wreckage" of tanked funds is surveyed by investors and corporates, according to broker Stifel.
Almost all investment companies have seen a share-price reaction over the past year, generally attributed to rising interest rates, with average discounts to net asset value (NAV) widened to 14% in the summer since hitting 15%, according to industry data.
There are only a handful of trusts with shares trading at a premium to NAV, the large remainder is the "wreckage" to which Stifel alludes.
With UK interest rates "hopefully" peaking at 5.5% at this Thursday's Bank of England meeting, Stifel analyst Iain Scouller took the chance to highlight sectors and funds with the potential to benefit from lower interest rates.
As we near the peak, he expects investors to focus on sectors and funds that have the potential to benefit from lower interest rates - even though economists are not forecasting the first interest rates cuts until next summer at least.
"We would hope that the reaching of the ‘peak’ may improve sentiment and encourage investors to have a look through some of the ‘wreckage’ amongst funds that have de-rated sharply in both price and discount terms against a background of rising interest rates over the past year," Scouller said in a note to clients.
Sectors that are most sensitive to interest rates include investment trusts focused on private equity, small and mid-caps stocks, UK equities, renewables, technology, biotech and debt funds.
Predatory M&A interest is seen as possible in the renewables sector, the analysts said, from either corporate buyers such as oil majors or private funds that may have significant cash to deploy in the renewables sector.
"We think the listed funds offer attractive ‘ready-made’ operational portfolios for corporates."
In terms of targets, it was noted that some solar funds have been trading on high discounts for a while and would be "small bites" for many oil and gas companies, while the larger listed portfolios may also interest corporates that want to quickly deploy significant sums "in the ground".
"Therefore, we don’t rule out takeover approaches for the larger funds, e.g., Greencoat UK, Greencoat Renewables and TRIG. We would expect a significant sector re-rating if a bid were to materialise."
Private equity has been among the hardest hit, due to the levered structures typically used in the private equity industry, the implications of higher debt costs on company earnings and the risk of valuation writedowns as a result of the falls in valuations of comparable-listed small and mid-cap companies.
Investment trusts in the private equity sector are typically trading on discounts of 30% to 40% to the most recent NAVs.
Similarly, those trusts investing in small and mid-cap companies are also rate sensitive, with a weighted average discount around 11% for mid-cap funds and 12% for those focused on small caps.
Stifel's preferred funds include Aberforth Smaller, BlackRock Throgmorton and Henderson Smaller.