Investment trusts can be a great choice, but their perceived complicated structures are rumoured to be the reason advisers turn their backs on the closed-end vehicles.
The closed-end nature of investment trusts is why there is often a difference between the share price and the value of the underlying assets (the net asset value – NAV). Most investment trusts trade at a discount to net asset value, although some trade at a premium.
Since 1999, investment trusts have been permitted to buy back their own shares in order to manage the gap between the trust’s share price and the value of the underlying assets held by the trust – its NAV per share. Where the share price is less than the NAV per share, the shares are said to be trading at a discount. This means buyers of the shares are gaining the benefit of the underlying assets for less than their face value.
However, the benefit of buying at a discount can only be crystallised if the discount is smaller – or has diminished entirely – at the time of sale. If the share price is higher than the NAV per share, the shares are trading at a premium.
Shares tend to trade at a discount when the supply of them is greater than the demand. By buying back shares, the board can mop up the oversupply.
The knowledge that a trust board is willing to buy back the shares if the discount widens helps instil confidence among investors, who may be less happy to buy shares that could see a significant future widening in their discount.
There are broadly two types of discount control mechanism (DCM), known as ‘hard’ and ‘soft’. A ‘hard’ DCM will state that the board must buy in shares if the discount to net asset value exceeds a certain amount.
Foreign & Colonial, for example, has a ‘hard’ DCM, which states that the board shall ‘vigorously defend’ its target of a maximum discount of 10 per cent by buying back shares.
F&C Global Smaller Companies is “committed to keeping the discount close to 5 per cent in more stable market conditions”, though this target takes into account the possibility of discounts widening in volatile conditions, where it may not be possible to meet this target.
A ‘soft’ DCM generally means the trust has the authority to buy back shares and may use this to manage the discount, but is not compelled to do so. This can be useful for those investing in less liquid asset classes, such as commercial property and smaller companies.
Jeremy Tigue, manager of Foreign & Colonial, says: “Hard DCMs are not suitable for all trusts but F&C’s buyback policy has been an unqualified success since its introduction in November 2005. Share price volatility has been reduced, net asset value per share enhanced, the shareholder base strengthened, the TER maintained and liquidity unaffected.”
According to AIC statistics to December 31 2011, the majority of investment trusts trading at a premium could be placed into two categories – absolute return orientated trusts and those with attractive yields.
The first group include the likes of Personal Assets, Lindsell Train and Ruffer Investment Company.
Simon Moore, investment trust analyst at Bestinvest, says: “The reasons why Personal Assets is trading on a premium is because it is run by people with a very cautious outlook – for those who still think that the world is more likely to go down than up. It isn’t worth selling – it is a safe haven fund – and one that never goes to a big discount because they control it in quite a narrow range.”
Murray International, which is an example of the high yielding trust in the second group, demonstrates the type of trust that may deserve to trade at a premium. It aims for capital and income growth from investing predominantly in an international portfolio of equities.
Mr Moore adds: “You could say this trust was on too much of a premium at
7 per cent, the reason why that might be is that it is investing in international equities and it is yielding nearly 4 per cent. If it was to trade at a discount that yield would be more like 5 or 6 per cent.
“It is not really trading to where its NAV is, it is trading on what kind of income people want, and that is from anywhere but the UK.”
Investment trusts that currently appear to be at, or near, their widest discount for a year and, therefore, represent a buying opportunity include BlueCrest AllBlue, Caledonia Investments and Picton Property Income.
The first is a multi-strategy hedge fund run internally by BlueCrest so it can monitor positions at all times and reallocate capital between strategies without being restricted by lock-ups. The AllBlue fund offers clients a focused, fettered fund of hedge funds from the BlueCrest group.
According to Mr Moore, one of the key attractions is that the BlueCrest management team will actively manage the allocation between these strategies to achieve their targets.
“Uniquely, BlueCrest are in the position of being able to view all the underlying trades across each strategy and thereby measure potential total portfolio risk and correlations. Its price has fallen but not its NAV, so the discount is widening,” he adds.
Jenny Lowe is features editor at Investment Adviser
