When markets are stretched it's tempting to run to cash, but three trusts take contrarian investor David Liddell's eye.
Despite all the 'known unknowns' - US election risk, Brexit, negative interest rates, European banking woes and rising geopolitical tensions, to name but a few - equity markets are currently basking in early autumn sunshine.
In the UK's case, with the FTSE 100 cracking 7000, this is partly the beneficial effect of the falling sterling exchange rate (now around $1.23) on those corporates with overseas earnings. Improving sentiment towards the oil and gas sector, as well as commodities, has also been helpful.
But it is not just the UK market enjoying its Indian summer; the FTSE All World index is up 4.5 per cent over the past three months. At the same time gilts have continued to make progress, with prices of longer-dated issues up 2.4 per cent.
The continued strength of both equities and government bonds is one of the worrying features of this rally; something has to give eventually, surely?
HEDGE FUNDS LOOKING INTERESTING
The contrarian at this point may be tempted to run for cash; but there are (nearly) always pockets of value to be found in the investment trust world. What we are looking for at the moment is trusts standing at good discounts which may have the ability to navigate potentially choppy waters ahead.
Hedge funds can (but don't necessarily) thrive under volatility and, although performance has been average recently and the majority of exposure is to the US market, Thirdpoint Offshore Investors (TPOG) stands at a discount of nearly 16 per cent.
The long-term performance is excellent: the underlying fund has returned 16 per cent annualised since launch in December 1996 against 7.4 per cent for the S&P 500 index.
The main underlying exposures are to equity positions of net 54 per cent (mainly US), with a long of 75.2 per cent and short of 21.2 per cent; and credit (i.e. a variety of debt positions) of net 29.1 per cent. The latter should be benefiting from the recovery in the oil and energy sectors.
The dividend policy is slightly difficult to interpret: it is intended to be 4-5 per cent of net asset value (NAV), to the extent that positive NAV performance is sufficient to support such a payout; which leaves it somewhat subjective.
Dividends of 81p and 87p were paid out in respect of 2013 and 2014, but nothing for 2015. In 2016 (to 30 September) the NAV is up 7.2 per cent.
Another hedge fund that is interesting is Acencia Debt Strategies; it invests in distressed debt situations and stands at a discount of 8 per cent. With sterling's weakness, the dividend yield should be around 4 per cent; but we slightly prefer TPOG as it is more diversified.
London & St. Lawrence (LSLI) has a solid long-term record, yields 4.3 per cent and is at a discount of 8 per cent.
Its main exposure (roughly 70 per cent) is to other investment trusts, such as Edinburgh, City of London and Merchants; this means it is both well-diversified and, to the extent that the underlying trusts are themselves on a discount, you can buy this exposure on a double discount.
We also like the look of BlackRock Income Strategies, previously the British Assets Trust, at a 9 per cent discount; its policy is now to be a multi-asset trust, investing in different asset classes all over the world.
This means it can be much more flexible than most trusts; however, the board has just announced a review. It may be best to wait and see how the management evolves.
Our last choice has the 'downside' of being entirely focused on UK assets; but Henderson Opportunities (HOT) is standing at a 20 per cent discount and can invest in a wide range of different-sized companies.
Its current holdings include giants such as HSBC, Shell and Rio Tinto - so there is international exposure in the underlying holdings - as well as smaller pharmaceuticals and technology companies.
James Henderson is the experienced manager of HOT and has a solid long-term record. One assumes he will not be disturbed by the recently announced merger of his employer and namesake with Janus Capital.
The author is founder of investment trust advisory service IpsoFacto, which offers a free two-month trial to new subscribers.
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