Calls for investment trusts to stamp out discount peril

Investment trusts have been urged to protect investors from wild fluctuations in their share prices if they want to finally secure status as a mainstream rival to mutual funds.

Trusts differ from mutual funds in that they are listed as companies on the stockmarket, so if demand for their shares falls, investors can lose money even if the underlying investment portfolio is rising.

But demand has risen in recent years and last month research showed that trusts are trading at their lowest average discounts in seven years – leading to fears that investors could lose out if they plunge back into deep discounts.

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“There is no reason why any investment trust specialising in equities or bonds should not have a discount control mechanism of some kind. Absolutely no reason at all,” said Charles Stanley fund analyst and investment trust specialist Stephen Peters. “I’m worried that a lot of trusts, and boards, where there has been a premium for a long time, are not thinking about risk.

“They don’t remember what it is like to trade on a 10 or 15 per cent discount.”

The research, from trust trade body the AIC, showed that trusts were trading at an average discount of 5.4 per cent. The AIC also said that, in the past year, six trusts have announced discount control mechanisms, in a sign that the industry is embracing the measure.

Under discount control mechanisms measures such as share buybacks must be used to automatically rein in discounts if they hit certain trigger levels. More drastic measures such as a tender offer or shifting into a mutual fund structure may follow.

Simon Elliott, head of research at Winterflood Securities, also said trusts should consider active discount policies. He said for investors it “would hurt a lot” to own a trust that slumps from trading at a 5 per cent share price premium to a 10 per cent discount. But he added that the move “has to be board-led” on trusts.

Oriel Securities analyst Tom Tuite Dalton pointed to the popular Finsbury Growth & Income trust run by Nick Train.

The board must use share buybacks, under which investment holdings are sold and the proceeds used to buy back and cancel shares to match the fall in demand, if its discount widens beyond 5 per cent.

“With the discount control in place, people were happy to put their money there,” said Mr Tuite Dalton.

Investment Adviser view:

One reason some boards might avoid discount control mechanisms is that they cut the size of a trust’s assets and so may also cut the asset manager’s fee income. They may also lead to continuation votes if discounts cannot be tamed. Investors should examine a trust’s discount policy carefully before buying in.