Taking advantage of investment trust discount opportunities created by market shocks such as the UK’s vote to leave the EU may have become more difficult because of a lack of liquidity, analysts have suggested.
The average investment trust discount widened out to 7 per cent as of the end of June, according to the Association of Investment Companies, a three-and-a-half year high.
The figure was up sharply from the 4 per cent average reported at the end of May, suggesting the Brexit vote had a part to play. But Mona Shah, senior research analyst at Rathbones, said the firm’s attempt to take advantage of this dislocation had been frustrated.
“At Rathbones, we like being quite vocal where the discounts have widened and we have seen some widen materially over the past couple of weeks, which are obviously opportunities.
“But actually, we have really struggled when trying to trade because the liquidity seems to have been sucked out and it has been a real source of frustration.”
Ms Shah suggested the rise of exchange-traded funds (ETFs), tracking indices in which investment trusts are included, had contributed to the problem.
“We have been trying to understand it because of course we have seen this market rally. We have observed it has been the ETFs sucking up all the liquidity in the market,” she said.
Hawksmoor’s Ben Conway, who buys investment trusts for the £55m Hawksmoor Distribution fund of funds, said investment trust liquidity had been an issue for some time, and suggested consolidation in the wealth management industry was at fault.
“These larger firms tend to have centralised buy lists and they need larger, more liquid investment trusts. Thus smaller [sub-£250m market cap] trusts tend to fall short of the requirements for making it onto these lists. The fewer smaller firms, the smaller the appetite generally for smaller trusts.”
Mr Conway said ETFs being obliged to buy investment trusts could actually help liquidity in some cases. If an ETF that had bought investment trust shares experienced outflows, for instance, it would then be forced to sell shares in the trust. This could provide a cheap opportunity for managers to buy shares.
“This can be great for us and such flows supply us with the liquidity we need to increase our positions in trusts we like as our own funds grow. We have noticed that trusts that have been newly promoted to indices do see a pick-up in liquidity, but the down side of this is increased volatility.
“We look to take advantage of this volatility, but it does make a previously relatively stable holding more volatile.”
If ETFs are having a negative impact on the liquidity of investment trusts, the impact is unlikely to be felt on a week-by-week basis, according to Sarah Godfrey, an investment companies analyst at Edison.
“Whenever [a trust] got into the FTSE, it was usually because the market had gone down and operating companies had gone down more than trusts had, hence boosting the ranking of the trust. But obviously the indices are only rebalanced periodically, so that’s unlikely to be a live issue.”
Anthony Leatham, Peel Hunt’s head of investment companies research, said investor bunching was a more likely cause of liquidity issues.
“A combination of anecdotal evidence and trading data suggests that the bigger issue might be everyone is facing the same way, particularly in those trusts with wider discounts. With very few sellers and shareholder registers that contain longer term holders, the liquidity has been more challenging.
“In aggregate, the flow that we have seen has involved almost every client looking to buy and sell the same things.”
