Opportunity amid madness: Valuations more attractive in wake of panic-driven price drops

First there was a wild, bubble-inducing mania, which produced meme stocks and saw companies in various sectors reach astronomical valuations, often on the back of little more than hastily-put-together pitch decks and some computer-rendered 3D imagery.

Moving into the end of last year and the first half of 2022, investors have gone into reverse gear. War in Ukraine, ongoing supply chain problems and inflation have all combined to put downward pressure on equities markets, with high-value companies being particularly affected.

The trouble with the former phenomenon is there is not much in the way of opportunity for investors. Other than telling your friend, ‘hey, maybe that car company is not worth 10x the combined value of all other listed car companies’ or ‘perhaps you should not buy a cryptocurrency named after a dog’, there is not much you can do except for sit on the sidelines and wait for things to become normal (whatever that means) again.

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It is a rather different story when prices are falling. Panic driven sell-offs are not renowned for being particularly discriminating, meaning good companies can fall just as much as the bad. This is not to say that many of the firms we saw reach massive valuations during the pandemic are now great buy opportunities. It is hard to see how companies with no earnings that went public at multi-billion-dollar valuations or who were swept up in utopian visions of future technological progress are likely to make great investments.

But the drawdowns we have seen so far in 2022 have led to price compressions almost across the board and there is an argument to be made that buy opportunities have arisen as a result. The trouble is that, just as it is hard to convince people to stop buying in a bubble, they become very tetchy about investing when markets come down again.

This seems to be a problem that BB Healthcare (BBH) is now facing. After regularly outperforming its benchmark and peers after its launch in late 2016, the closed-end fund has had a tougher time since the final quarter of last year. That is likely to be because of the trust’s skew towards the mid-size companies that managers Paul Major and Brett Darke believe are likely to deliver the best returns.

Paul and Brett have been saying for several months that they believe the current market will be seen as a major historical buy opportunity. They have also taken steps which suggest those aren’t just idle words. Despite seeing a drop in its NAV and share price, the managers have used gearing to acquire new companies and have not seen any major change in the fundamentals to the businesses they already hold.

It is unlikely the trust is going to see a sudden bounce back in performance in the near term, given how volatile markets still are. But for long-term investors, the trust’s current discount – a rarity since its launch – may prove an attractive entry point.

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It is a similar story with Ashoka India Equity (AIE). The trust has been the best performer in its peer group since holding its IPO in 2018 but has seen its NAV and share price drop in 2022, along with the wider Indian stock market. But as with BBH, it is hard to see how the long-term fundamentals have changed for many of the companies in their portfolio.

The trust managers place a heavy emphasis on strong cash flows and quality, traits which one would imagine are more likely to ensure the companies they own can survive in a tougher economic environment. Companies like Infosys and Asian Paints, for example, have continued to deliver strong earnings growth into 2022.

AIE also has a unique structure, where no annual management fee is charged and the asset manager – White Oak Capital – only get paid 0.3% of any outperformance they produce relative to the benchmark over three year periods. Those fees are paid in shares, half of which are locked in for an additional three years.

That reflects the managers’ long-term outlook but also the confidence they have in their ability to deliver returns for shareholders. AIE may not experience a sudden bounceback in performance over the next couple of months. But the trust, which is trading at a rare discount to NAV, remains an attractive option for the long run, even if the chaos we have seen so far this year makes it seem otherwise.

David Kimberley is an investment trusts writer at Kepler & Partners

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