According to data from the AIC, the average investment trust discount to net asset value has widened from 12.2% at the end of 2022 to 14.5% as of 8 September 2023, while sector averages have generally widened. The exception is private equity, which narrowed from 25.1% to 4.5%, skewed by 3i’s (III) dramatic swing from discount to premium.

While this presents an opportunity to buy into parts of the market cheaply, it’s unlikely that the board of directors for each affected trust will be sitting back and doing nothing. They will be under pressure from shareholders to find ways to narrow the discounts, and it is here that investors might want to look closely.

Any signs that action is being taken to narrow the discount implies you could make money as the gap is closed.

Annabel Brodie-Smith, communications director of the Association of Investment Companies, says: ‘Many analysts believe these wider discounts present long-term buying opportunities and, in the past, brave investors who have invested in turbulent markets have been richly rewarded.’

PROACTIVE RESPONSE

Wide and persistent share price discounts to NAV on investment trusts arise when demand for the stock falls out of sync with the value of the underlying investments. Stubbornly wide discounts can wipe out long-term investment performance so investment trusts need to do something to stop the rot setting in.

Brodie-Smith explains that in recent years investment trust boards have been ‘proactive and creative in looking for ways to deliver shareholder value’ and says this year the pace has stepped up.

Boards have proposed mergers, fee changes and the wind-up of investment trusts as well as implementing share buybacks at record levels. Several strategic reviews are under way, which are likely to lead to more consolidation in the final quarter of the year.

Her view chimes with that of Kepler analyst Ryan Lightfoot-Aminoff, who says boards have stepped up and shown their ability to add value, using all the tools available to them to help generate returns for shareholders.

Analysts at investment bank Stifel note that a high number of continuation votes are due in the alternative trusts space with investors left frustrated at the lack of proactive action being taken to address wide discounts. But they believe boards have ‘heard the message loud and clear’ and expect continuation votes will ‘focus minds towards what more can be done’.

LEVERS TO PULL

Winterflood’s head of investment trust research Emma Bird says in recent years, an increasing number of trusts have introduced enhanced dividend policies (i.e., paying dividends at least partially out of capital profits) in an attempt to bring in discounts by appealing to a wider range of investors.

Another way to deal with the situation is to have a discount control mechanism, which means the trust buys back shares to help the price trade as close as possible to net asset value. Should the trust trade at a premium, trusts can issue new shares to bring the price closer to NAV.

Examples of trusts with a discount control mechanism include Troy Income & Growth Trust (TIGT), Personal Assets Trust (PNL), STS Global Income & Growth (STS) and Capital Gearing (CGT).

PANTHEON SETS THE STANDARD FOR PRIVATE EQUITY

Despite an excellent long-run performance record, 14 out of 17 trusts in the AIC’s private equity sector trade on double-digit NAV discounts amid concerns over portfolio valuations in a higher rates environment.

The board of Pantheon International (PIN), the FTSE 250 trust chaired by John Singer, recently sprang into action, committing up to £200 million to buy back shares in a bid to drive a re-rating. This is beginning to have a positive effect, with the discount narrowing from a 12-month average of 44% to 36.4%, admittedly still wide, at the time of writing.

Investec says Pantheon’s enhanced capital allocation policy ‘throws down the gauntlet’ to the rest of the listed private equity sector, increasing pressure on companies to take tangible action to prioritise shareholder returns and address both the absolute level of discounts and discount volatility.

The broker adds that ‘the somewhat toothless defence’ of discounts last year was ‘a deeply underwhelming experience’, and it believes permanent capital has been taken a little too literally and bred complacency across the sector.

GREENWOOD SPIES ‘GOLDEN OPPORTUNITY’ 

Nick Greenwood is the manager of MIGO Opportunities Trust (MIGO), which takes stakes in other investment trusts trading at discounts, typically funds that are misunderstood by generalist investors.

Greenwood says the rapid widening of discounts means we have reached the point where many commentators are suggesting that recent events have sounded the death knell for investment trusts. ‘This is a call that we have heard many times over the decades, however, as the sector continues to evolve, natural selection remains alive and well in the world of investment trusts.’

He adds: ‘A fundamental reason why the trust sector should prosper is that asset classes such as property, private equity and shipping cannot operate as open-ended funds. It would be impossible to sell a fraction of an office block or a container ship within twenty-four hours to meet a client sale.’ Greenwood firmly believes that ‘we will look back at the summer of 2023 and reflect that it represented a golden opportunity to buy discounted investment trusts.’ 

CLOSURES AND TAKEOVERS

Boards of sub-scale trusts are biting the bullet and leaning into size and liquidity challenges, with the market witnessing more mergers, strategic reviews and wind downs.

Examples include Abrdn Latin American, wound up earlier this year with the board citing the fund’s (lack of) scale, as well as two small-scale debt funds that are winding down their portfolios and returning proceeds to shareholders; RM Infrastructure Income (RMII) has consistently traded on a discount since the onset of Covid in 2020 while Blackstone Loan Financing (BGLP) is off the radar of most investors, languishing on a cavernous 35% NAV discount.

Unhappy with a 30% discount, Ecofin US Renewables Infrastructure’s (RNEW) board has launched a strategic review which will centre on a sale of the assets which if successful, will result in a winding up with cash returned to shareholders.

Regional REIT (RGL) is trading on a 48% discount to net asset value, the widest in the UK commercial property peer group. Emma Bird at Winterflood believes that situation could make it a takeover target. She says it may offer ‘an interesting trading opportunity’ with a fully covered 13.7% dividend yield offering ‘some downside protection’.

A takeover offer for Round Hill Music Royalty Fund (RHM) was announced on 8 September 2023 which Stifel thinks will ‘reflect the starting gun being fired on a wave of corporate activity in the listed alternative sector’ in time.

Round Hill Music Royalty Fund has accepted a cash offer of $1.15 per share from Alchemy Copyrights, a 67.3% premium to the undisturbed share price and an 11.5% discount to NAV, amid shareholder frustration at the persistent discount.

MAKING PROGRESS 

James Carthew, head of investment companies at QuotedData, has been ‘generally impressed’ by the way boards are responding to widening discounts.

‘It feels as though they have been swifter to act and are being more radical in their thinking than in previous downturns,’ he tells Shares. ‘Unfortunately, this is not stemming the tide of selling, as yet.’

Carthew says the most obvious response has been far more share buybacks, which rebalance supply and demand and allow share prices to recover.

‘Back in January this year, 69 investment trusts repurchased £191 million worth of shares, offset by £86.9 million worth of share issuance by 20 trusts,’ explains Carthew. ‘In August, £399 million worth of stock was bought back by 93 investment trusts.’

Discounts have emerged on trusts that have almost always traded at premiums since launch, with Pantheon Infrastructure (PINT), Downing Renewables & Infrastructure (DORE) and Aquila European Renewables (AERI) buying back stock.

‘Others, such as NextEnergy Solar Fund (NESF) and Triple Point Social Housing (SOHO), are selling off part of their portfolio as a way of demonstrating the accuracy of their NAVs and freeing up cash to tackle discounts.’

MERGERS GALORE

Smaller trusts on big discounts are being absorbed by larger ones, with five mergers are already proposed this year, the same amount as seen in the whole of 2022.

Nippon Active Value Fund (NAVF) is absorbing Abrdn Japan (AJIT) and Atlantis Japan Growth (AJG). Abrdn New Dawn (ABD) is being folded into Asia Dragon Trust (DGN) in a move that will create an enlarged trust with a market cap big enough for FTSE 250 inclusion.

Elsewhere, Abrdn Smaller Companies Income (ASCI) will roll over its assets into Shires Income (SHRS), and GCP Infrastructure Investments (GCP) plans to merge with GCP Asset Backed Income (GABI) in a move creating a much bigger vehicle and one able to fund share buybacks.

Kepler’s Lightfoot-Aminoff says: ‘Despite the malaise in the sector, boards have shown they can add value to investment trusts by creating catalysts for discounts to narrow and value to be realised.’ He adds: ‘These are not easy decisions for boards to take, but we salute their valuable role in providing multiple routes for shareholders to make good returns from buying assets at wide discounts.’

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