A beleagured investment company market is looking for signs of a post-Budget recovery in share prices after suffering a wave of investor selling ahead of yesterday’s hike in capital gains tax.

Unrealised fears chancellor Rachel Reeves would use Labour’s first Budget in 14 years to align capital gains tax (CGT) with income tax prompted investors to take profits on long-standing share holdings outside pensions and ISAs.

As a result, in recent weeks a wide range of listed funds have fallen to wider-than-average discounts, such as Aberforth Geared Value & Income, Majedie (MAJE ), 3i Infrastructure (3IN ) and Literacy Capital (BOOK ), which may reflect this selling pressure.

The average investment company discount has widened to nearly 15%, although it remains below the 18.5% trough reached at the end of last year.

Stifel analyst Iain Scouller said the rise in CGT rates to 18% and 24% from 10% and 20% should bring a halt to tax-related selling. The immediate implementation of the rises has provoked complaints but Scouller believed this was preferable to delaying it until the new financial year in April which ‘would have likely led to a drip-drip of selling over the next five months’.

This morning, Aberforth Geared, a smaller companies trust launched in July as the rollover vehicle to its predecessor Aberforth Split Level, rose 3p, or 3.5%, to 89p, narrowing the 16.7% discount at which it closed yesterday.

However, that also reflects a relief rally in UK smaller companies following the Budget, with other small-cap funds such as Strategic Equity Capital (SEC ) and Odyssean (OIT ) among the initial risers this morning.

Scanning for red flags

Peel Hunt analyst Anthony Leatham said he was ‘watching closely for reactions in the UK bond market’ for a possible warning sign for investment companies invested in ‘alternative’ assets such as infrastructure and real estate.

Concerns that the government’s borrowing and spending plans will see interest rates stay higher for longer have knocked gilt prices again today, lifting their yields to a fresh post-election high. The risk for infrastructure funds, viewed as ‘bond proxies’ for their reliable income streams, is that higher gilt yields (and lower gilt prices) will depress the valuation of their assets. That could widen the already large 20% average gap between their shares and the net asset values of their portfolios.

On the other hand, Leatham said the rise in CGT could encourage investors to look towards high yielding investment trusts. The 20 highest yielding trusts over £200m offered an average 9.4% yield, significantly better than the current 10-year gilt yield of around 4.4%, he said.

Deutsche Numis analyst Ewan Lovett-Turner said while the spike in gilt yields was a ‘headwind’ for infrastructure and renewable funds, ‘we continue to be comfortable with valuation discount rates given they remain at healthy premiums over risk-free rates. Moreover, funds continue to dispose or syndicate in line or ahead of valuations suggesting NAVs [net asset values] are robust.’

Growth boost

Leatham was also hopeful the chancellor’s pro-growth Budget boost to spending on infrastructure could restore sentiment towards smaller and mid-cap stocks,  lifting demand for trusts investing outside the FTSE 100, and also private equity funds, which currently trail on average discounts of 18% and 30%.

Stifel said an increase in tax on the carried interest, or profits, earned from private equity fund managers on disposals would only have a small impact on realisation decisions, which Scouller said were more influenced by pricing, growth prospects and market conditions.

‘The funds that have the highest exposure to the UK market are CT Private Equity (CTPE ) at 40% of the portfolio and HgCapital (HGT ) at 34% of the portfolio. Many of the other funds are much more US focused and therefore under a different carried interest tax regime,’ he said.