Unlike open-ended funds, trusts tend to have a fixed number of shares in issue, which means the shares can trade at a premium, or discount, to the net asset value of the underlying investment business. Therefore, investors can buy the trust at a discount to its net asset value. 

Meanwhile, they also have more flexibility when it comes to dividends. Investment trusts can hold back a percentage of their revenues received every year. Managers can then use this at a later date to fund dividends.

These reserves were particularly handy last year when many companies cut their dividend payouts. Most investment trusts were able to dig into their reserves to fund their own dividends. 

These are some of the reasons why I like investment trusts. Here are two trusts I’d buy today for my portfolio. 

Investment trusts to buy

Another reason to own investment trusts is that they can offer a good way for investors to gain access to regions they may not be able to access on their own. The JP Morgan Indian (LSE: JII) is a great example. This company invests in a diversified portfolio of equity and equity-related securities of Indian corporations.

I think India has the chance to be one of the fastest-growing economies in the world over the next few decades. It has a young and growing population, with increasing education levels and growing wealth. However, I wouldn’t know where to start investing in the country. That’s why I’d buy JP Morgan’s Indian offering.

Its top holding is Infosys, a global leader in next-generation digital services and consulting with operations worldwide. It also has investments in Indian housing corporations, construction companies and banks. The investment trust currently trades at a 14% discount to its net asset value. 

This trust’s concentrated portfolio may put some investors off. For example, it has 20% of assets invested in its top two holdings. This high level of concentration could expose investors to risks and losses if the companies in the portfolio don’t perform as expected. 

UK focus

The other stock I’d buy for my portfolio of investment trusts is Mercantile (LSE: MRC). This investment firm has a UK focus. Specifically, the fund managers focus on buying mid-cap UK companies. Two of the top holdings are Bellway and Games Workshop. 

I like this trust because it offers the chance to invest in a diversified portfolio of mid-cap, high-quality UK growth stocks at the click of a button. The stock also currently offers a dividend yield of 2.4%. Further, it trades at a discount of 5% to the net asset value. 

This might not be suitable for investors who aren’t interested in the UK. Risks such as a sluggish recovery from the coronavirus pandemic and Brexit-related disruption could hold back the returns on UK equities as we advance. 

Despite these risks, I’d buy the stock from my portfolio of investment trusts. 

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But I’m not convinced. I think it’s going to be some time before this company can return to 2019 levels of probability. 

That doesn’t mean I’m avoiding all UK shares entirely. In fact, I’m incredibly optimistic about the outlook for UK equities in general. Although I think it’s sensible to focus on high-quality businesses and diversified funds. 

Forget the Cineworld share price

On the face of it, the Cineworld share price looks cheap. Both from a fundamental perspective and compared to the stock’s trading history.

However, that doesn’t necessarily mean the stock will be an excellent addition to my portfolio. So far, Cineworld has been able to navigate the pandemic. But it’s also built up an enormous amount of debt in the process. I think this additional borrowing will prove to be a drag on profits for many years to come. Profits will go to repaying creditors rather than rewarding shareholders. 

As such, I think owning the Cineworld share is a bit of a gamble. I’m not particularly interested in gambling with my money. 

Many other UK shares look to be better investments, in my opinion. 

Other UK shares to buy 

One of the ways I’m investing in these companies is with the Mercantile Investment Trust (LSE: MRC). This trust owns a broadly diversified portfolio of high-quality small- and mid-cap stocks. Top holdings include the tabletop games company Games Workshop and homebuilder Bellway. 

Investors could own these stocks individually in a portfolio, but I think there are added benefits from the portfolio diversification. In my view, the entire UK market is undervalued.

However, considering the mixed economic outlook for the UK economy, I think some businesses will perform significantly better than others in the near term. So, rather than trying to pick winners and losers, I’ve chosen to own a basket of the market’s best companies by acquiring Mercantile. 

Another advantage of owning UK shares in this way is the income credentials of the trust. It currently offers a dividend yield of 3%. This is relatively secure because investment trusts can hold over a portion of their revenue every year to cover dividend payouts in times of uncertainty.

This quirk has been hugely valuable in 2020 as many companies have slashed their dividends to preserve cash in the pandemic. Indeed, the Cineworld share price plunged when the company eliminated its dividend. 

Therefore, while shares in Cineworld may continue to rise, I think the company’s outlook is too uncertain. That means shareholders are unlikely to see any significant income from dividends until the creditors are paid off.

Meanwhile, Mercantile offers a 3% dividend yield and a way to own some of the UK’s top companies at the click of a button. That’s why I prefer to hold the investment trust rather than the Cineworld share price.

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Why the stock market?

At the Fool, we believe stock market investments generally provide the best long-term results. As I’ll explain, even a relatively small amount of cash, such as £1,000, is enough to give you broad exposure to different types of business, plus a regular income.

You can also keep stock market investments in a Stocks and Shares ISA, avoiding any future tax bills. That simply isn’t true with most other asset classes, such as property or gold.

How to invest #1: buy shares directly

The most obvious way to invest in the stock market is to buy shares in one or more companies. But with a budget of £1,000, I don’t think this is a good choice.

To avoid losing too much in dealing charges, the absolute minimum I’d invest in a single stock is £500. On a budget of £1,000, that means a maximum portfolio of two stocks. In my view, this isn’t a good idea. It means that all your eggs are in one (or two) baskets.

If something goes wrong, you could easily lose a quarter of your investment in one day. And even if the market rises, you may not be exposed to winning sectors.

How to invest #2: buy an index tracker

A more sensible choice would be buy an index tracker fund. These cheap, simple passive funds simply follow the performance of a major stock market index. My choice would be a FTSE 100 tracker fund.

At current levels, this should provide a dividend yield of about 3.5%, even after this year’s widespread dividend cuts. Over time, I’d expect this payout to rise steadily. And, in my view, the index is quite attractively priced at around 6,000, so I’d also expect capital gains over time.

However, that’s not actually how I’d invest £1,000 today. Let me explain what I’d really do.

What I’d buy today

If I was investing that sum today, I’d buy shares in an investment trust. These unfashionable vehicles are sometimes overlooked but, in my view, they’re a great tool for long-term investors.

One particular attraction is that they’re allowed to hold back some of the income they generate each year. This can be used to ‘smooth’ out dividend payments in future years, protecting shareholders (you and me) from cuts.

There are hundreds of trusts to choose from on the London market, but the one I’d buy today for a starter portfolio would probably be the Mercantile Investment Trust (LSE: MRC). Founded in 1884, this trust invests in mid-sized companies which the trust’s managers think will do well in the future.

Mercantile’s strategy has worked well in recent years — shares in the trust have doubled over the last 10 years. The FTSE 100 has risen by just 10% over the same period.

The Mercantile Investment Trust currently offers a dividend yield of around 3.4% and the shares trade at a discount of around 5% to their book value. I think that now could be a good time to buy.

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Managed portfolio

The great thing about investment trusts is that you do not have to worry about the day-to-day management of the investments these companies own. The portfolios are managed by professional investors, with specific mandates.

The Scottish Mortgage Investment Trust (LSE: SMT) is a fantastic example of the benefits of investment trusts.

Overseen by fund manager James Anderson since April 2000, Scottish Mortgage has smashed its benchmark over the past five years by investing off the beaten track.

Anderson has an excellent record of picking growth stocks and holding on to them for years. There are currently around 85 holdings in the portfolio, including 44 unlisted investments. These unlisted investments do present a risk, but considering the diversification of the portfolio overall, I’m not too concerned about Anderson’s private market holdings.

Indeed, Amazon.com, one of the world’s largest tech companies, is by far the largest holding in the portfolio, making up around 9% of assets under management.

Scottish Mortage charges an annual management fee of 0.3% and offers a dividend yield of 0.6%. For most investors, it would be difficult to replicate the same kind of diversification and exposure to private investments without incurring substantial costs.

Small-cap growth

The Mercantile Investment Trust (LSE: MRC) could also be a great alternative to buy to let property, in my opinion. This investment trust is a mid-cap fund. It has a well-diversified portfolio, with no holding accounting for more than 4.1% of assets under management.

It has returned 100% over the past five years, excluding dividends, outperforming its benchmark by more than 50%.

Mercantile might not have the international exposure of Scottish Mortgage, but it does own some of the UK’s fastest-growing companies.

Mid-cap companies tend to produce better returns than large-caps over the long term because they have higher growth rates. This growth has also helped support the trust’s dividend, which currently stands at 2.7%. The annual management fee is just 0.4%.

Global diversification

The third and final investment trust that I am going to profile in this article is the Witan Investment Trust (LSE: WTAN).

Witan has a more diversified investment approach than both Scottish Mortgage and Mercantile, which has hurt returns, but if you are looking for stability, this might be the one for you. The largest holding in the portfolio does not exceed 2.5% of net asset value, and over the past five years, Witan has produced a total return for investors of nearly 70%.

Its portfolio is spread all over the world with around 20% of assets invested in UK equities, 20% in European equities and 20% in North American equities, and the remainder spread across the rest of the world.

At the time of writing, it supports a dividend yield of 2.3% and charges an annual management fee of 0.4%.

It is currently dealing at a discount to its net asset value of around 4%, so you can buy this portfolio of international growth stocks at a substantial discount to intrinsic value today.

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Managed by James Anderson and Tom Slater, the duo is on the lookout for companies that have the potential to disrupt industries. This objective has led it to invest in tech giants such as Tesla and Amazon before many other managers here in the UK cottoned on to the potential of these businesses. 

These astute investments have helped the trust produce a return of 164% for investors over the past five years compared to the Investment Trust Global benchmark return of 74%.

On a discount 

Until recently, investors had been clamouring to buy into Scottish Mortgage, paying a premium to do so. Over the past five years, the trust has traded at an average premium to the underlying net asset value of around 5%. 

However, over the past few weeks this discount has narrowed, and today, the shares in the trust are trading at around net asset value.

There have only been a few occasions in the past five years when investors have been able to buy the shares without having to pay a premium. With this being the case, I think it could be worth snapping up a few shares in this winning, globally diversified investment trust for 2019. 

Small-cap exposure 

Another investment trust that’s recently caught my eye is the Mercantile Investment Trust (LSE: MRC). 

While Scottish Mortage has a global focus, Mercantile aims to “achieve capital growth through investing in a diversified portfolio of UK medium and smaller companies.” Recently, Brexit concerns have weighed on the shares wiping out almost 12 months of gains at the trust. Nevertheless, I’m confident that over the long term, Mercantile can recover. 

The trust has been managed by Martin Hudson since 1994 and does have an impressive track record. Over the past five years, it has beaten its benchmark by 13.2%. On top of this remarkable performance, it also offers a dividend yield of 3.3%, and the shareholder-focused management has pushed down the average annual management fee to a modest 0.45%. 

Right now, shares in Mercantile are on special offer. They are trading at a discount to net asset value of 11.9%, a considerable gap and one that management is trying to moderate with share buybacks. Over the past five years, the discount to net asset value has averaged 10.4%.

If you’re looking for a way to invest in beaten-down UK small-caps, I think this could be the best investment to do so. You’re getting a diversified portfolio of companies, managed by a seasoned investment manager who is committed to producing the best returns for investors. 

So overall, I reckon these two investment trusts are a sensible buy for 2019 considering their current valuations and record of creating value for shareholders.

The post 2 deeply discounted investment trusts I’m buying for 2019 appeared first on The Motley Fool UK.

Mercantile has a solid record of achieving this goal. Over the past decade, the trust’s net asset value has grown by 205%, outperforming its benchmark by 15% over the same period. This return shows portfolio manager Martin Hudson, who’s been at the helm since 1994, knows a thing or two about picking stocks. 

And one of the primary reasons why this trust, rather than any of its peers, occupies a significant percentage of my portfolio is the fact that it only charges 0.45% per annum to manage investors’ money — that’s less than half of the UK average fund fee of 1.13%.

What’s not to like? 

Unfortunately, the one downside about the Mercantile trust is its current lack of yield. The stock supports a dividend yield of 2.3%, paid quarterly. Still, a low yield is more reflective of the company’s high allocation to small-caps, which tend to reinvest cash back into the business rather than paying it out to investors. What’s more, with capital growth averaging 17% per annum since 2009, I’m not overly concerned about the lack of yield. 

At the time of writing, shares in the Mercantile trust are trading at a 9.5% discount to net asset value. 

If it’s dividends you’re after, Merchants Trust (LSE: MRCH) could be the perfect investment for you. Merchants is focused on providing the best dividend possible for investors. Today, the trust supports a dividend yield of 5.3%, and some of its most substantial holdings include FTSE 100 income champions such as HSBC and BP. 

Dividend Hero 

Merchants has a long history of dividend investing. The company has increased its dividend yield to investors for 36 consecutive years, a record that has earned the firm ‘Dividend Hero’ status from the Association of Investment Companies. To be awarded this status, investment trusts must have a record of dividend increases for at least two decades. 

Just like Mercantile, Merchants is also low-cost compared to its sector peers. Specifically, the trust currently charges only 0.6% per annum, around the same level as other passive income-focused funds. The company trades at a 4.5% discount to net asset value. 

If you’re looking for a dividend champion to add to your ISA, Merchants certainly deserves your attention. Today the company reported, alongside its full-year results, that net asset value increased 14.5% for 2017, outperforming the FTSE 100’s return of 11.3%. Over the longer term, the trust has outperformed as well, producing a NAV return of 49.1% over five years, compared to the FTSE 100’s performance of 45.9% over the same period. The income distribution has exceeded the wider index’s by more than 1.2% over this period. 

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However, a number of investment trusts continue to trade at a discount to their net asset values. This could indicate that they offer good value for money. And since they offer a high level of diversification, they could prove to be worthwhile buys for the long run. Here are two trusts that could be worth a closer look.

Impressive performance

Reporting on Thursday was internationally-focused business Alliance Trust (LSE: ATST). The company experienced a year of significant change during 2017. Notably, it changed investment manager and implemented a new investment approach. This provides those putting their cash into the company with exposure to a number of global equity managers who are investing in high-conviction ideas.

The trust delivered a total shareholder return of 19.2% during 2017. This compares to the MSCI ACWI total return of 13.8% during the same time period. This is a positive result at a time when global stock markets experienced a bull market. Since the company has exposure to a variety of shares in a number of different regions internationally, it could be set to benefit from further improvements in the outlook for the global economy.

With Alliance Trust trading at a discount of around 6% to its net asset value, it appears to offer good value for money. Since it has a significant amount of diversification and a good track record of growth, it could be a sound purchase for a starter portfolio.

Growth potential

Also offering long-term growth potential is the Mercantile Investment Trust (LSE: MRC). The company is invested solely in UK equities, with its major holdings having a bias towards mid-caps. Historically, mid-caps have outperformed larger companies and are often seen as more volatile and risky, but with higher return potential.

Certainly, investing in FTSE 250 stocks prior to Brexit could be seen as a risky move. In many cases, they are focused on the UK economy and so a further decline in the forecast GDP growth rate could lead to difficult trading conditions for them.

However, with the Mercantile Investment Trust having delivered total returns of 92% in the last five years versus a return of 51% for the UK all companies sector, it has a solid track record of outperformance. Furthermore, since it trades at a discount to net asset value of 9%, it appears to offer good value for money.

While the prospects for UK equities could be uncertain, the reality is that their risk/reward ratios could be enticing due to investors having priced-in potential risks. As such, the trust could be a worthwhile purchase for a starter portfolio.

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REIT stuff

Today the trust has published its full-year results to 31 December 2017 and the market is quietly satisfied, with the share price up 1.72% at time of writing. It delivered a total return of 15.2%, up an impressive 58.3% on last year’s 9.6p, beating its target of 9% a year over the medium term. EPRA net asset value per share increased 10.3% to 142.24p, while dividends totalled 6.4p per share, in line with its target. This is a modest 3.2% rise on last year’s 6.2p.

Profit before tax rose 169.6% to £247.8m with the contracted annual rent roll up 26.2% to £125.95m. The group now has a market capitalisation of £2.03bn, with its portfolio independently valued at £2.61bn, spread across 46 assets plus 114 acres of strategic land.

Big and Boxy

Tritax raised £350m of equity through a substantially oversubscribed share issue and continues to expand, acquiring 11 big boxes during the year with an aggregate purchase price of £434.99m, further diversifying the portfolio by geography and tenant.

This is a company that even sees a bright side to Brexit uncertainty, as chairman Richard Jewson pointed out: “Brexit may provide a silver lining, since with increased border controls our customers will require more warehousing domestically, further supporting our business case.”

Last month Paul Summers highlighted the stock for those wanting solid dividend income, and it is hard to disagree after today’s update. The forecast yield is currently 4.8%, historic yield 4.56%. The investment trust is still trading at a premium of 7%, which makes me slightly uncomfortable, but that is also evidence of investor demand, as is the premium forward valuation of 18.6 times earnings.

Mid-cap marvel

If you prefer to buy your investment trusts when they are trading at a discount, as most are, you might like to consider Mercantile Investment Trust (LSE: MRC). The £2bn trust, run by JP Morgan, has a fine historic pedigree, having been established in 1884. It targets medium and smaller UK companies outside the FTSE 100 and is up 19% in the last 12 months, and 90% over five years, according to Trustnet.com. My Foolish colleague Peter Stephens is particularly excited by its prospects.

Fund manager Guy Anderson looks for companies that have significant room for growth and are not recognised by other investors. 2017 was a very good year for mid-caps, although lately 2018 has not been as good, something that could be said for global stock markets as a whole.

Trust me

The trust offers broad diversification, with its largest holding, Bellway, making up just 2.5% of the portfolio. Other top holdings such as Man Group, Intermediate Capital, Spirax Sarco, Sophos and Jupiter Fund Management should give you a flavour of its portfolio. It pays quarterly dividends which it aims to grow at least in line with inflation. Currently it yields 2.21%. The growth is the thing, though. It may complement Tritax’s steady dividend flow quite nicely.

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Trust this

The Mercantile Investment Trust (LSE: MRC) reported its results for the six months to 31 July today and gladdened loyal investors with a 16.2% return on net assets, beating 10.7% on the company’s benchmark index. The return to shareholders was 14.5%, as the discount at which the shares trade widened slightly over the half year. It also paid a total dividend of 21p, up from 20.5p in 2016.

Mercantile is managed by JP Morgan and aims to achieve capital growth through a portfolio of UK medium and small company stocks. Long-term performance has been solid, it has returned 120% over the past five years, according to figures from Trustnet.com, and 23% over 12 months. Gearing is relatively modest at 3%.

Cheap and cheerful

Management invests across a spread of sectors but with a tilt towards financial services, where its position in private equity investor 3i performed notably well. It wisely minimised its exposure to the troubled oil services sector. There is plenty of concern about the state of the UK economy but the trust’s joint managers remain relatively positive. “The economy is proving to be more resilient than had been expected and monetary policy has been accommodating. These factors combined should provide a positive backdrop for equities.”

Mercantile, which now manages a hefty £1.66bn, currently trades at a discount of 9.86%, which I find reassuring as I dislike buying trusts at a premium to net asset value. Ongoing fund charges total just 0.5% a year, and the current yield is 2.32%. Investing in this trust could prove good business.

Go Nimmo

Standard Life UK Smaller Companies Trust (LSE: SLS) is another long-standing investor favourite, and this £310m investment trust has also performed smartly, returning 29% over 12 months, and 115% over five years. That comes as no surprise when you discover it is run by smaller companies whizz Harry Nimmo, who was renowned when I first started writing about investment trusts 15 years ago, and has been running this one since 2003.

Nimmo’s biggest holding right now is Foolish favourite Fevertree Drinks, which makes up 5% of his portfolio, and has more than justified its place with its fizzy recent performance. Some 10% of the portfolio is invested in the FTSE 250, with the remainder split between the Numis Smaller Companies index and AIM. The yield is just 1.48%, more than you might expect on a smaller companies fund, but charges are higher than on Mercantile, with a total expense ratio of 1.17% a year. So far, Nimmo has been worth the money.

Think small

The trust trades at a discount of -5.43% to net asset value. Personally, I wouldn’t have been surprised if it traded at a premium, given Nimmo’s reputation. If buying individual smaller companies stocks is too risky for you, either of these trusts could do the job very nicely on your behalf. Small is beautiful

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Impressive performance

Rising by 128% in the last five years is the Mercantile Investment Trust (LSE: MRC). It focuses on mid and small-cap UK stocks, and they could help it to deliver impressive returns in future. One reason for this is the uncertainty surrounding the UK economy. With Brexit causing consumer and business confidence to come under pressure following a spike in inflation, many investors are focusing to a greater extent on larger, more internationally-exposed companies. This could mean their smaller peers offer wider margins of safety at the present time.

The company’s performance puts it in the top quartile of its sector over the last three years. Despite its strong performance, it continues to trade at a 10% discount to its NAV. This suggests there could be even greater capital growth potential on offer. It also has a dividend yield of 2.3%, which is only 30 basis points lower than inflation at the present time. The trust aims to keep dividend growth as close to inflation as possible in the long run, which could make it of interest to income investors.

However, the main focus of the Mercantile Investment Trust is capital growth. Holdings such as Bellway, Auto Trader and Just Eat mean that it has the potential to deliver further outperformance of the FTSE 100 in the next five years.

Value focus

Also offering upside potential in the long run is the Jupiter UK Growth Investment Trust (LSE: JUKG). It has delivered a total return of 69% during the last five years. This puts it well ahead of the FTSE 100’s performance during the same time period. Despite this, it trades at a 3% discount to its NAV and this indicates it could offer further upside over the medium term.

The trust has a number of value opportunities within its major holdings. For example, its top 10 holdings include companies such as Lloyds and Barclays – both of which trade on relatively low price-to-earnings ratios.

Similarly, stocks such as Taylor Wimpey and IAG could deliver long-term growth because of low valuations which have been brought about by uncertain market conditions. And with a number of smaller companies included within its holdings, the trust has exposure to potentially fast-growing areas, too. Therefore, it could deliver further outperformance of the FTSE 100 in the long run.

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