Interactive Investor

Bargain Hunter: three trusts shaking things up to tackle their big discounts

7th December 2021 10:36

Kyle Caldwell from interactive investor

There are various tools a board can use in an attempt to boost demand for shares. Here are some examples.

When an investment trust is persistently out of favour, its board can spring into action in an attempt to tackle its discount.

There are various tools at a board’s disposal to attempt to boost demand for shares, which will, in theory, reduce the trust’s discount. The most drastic is the ability to sack the fund manager, as well as the fund management group.

Unlike football sackings, these do not happen frequently, typically a couple of times a year for the overall sector. But what the two have in common is that under new management there are no guarantees that there will be a marked improvement in performance. 

Change at the top

In a bid to improve performance, a recent management group change saw Genesis Emerging Markets turn into Fidelity Emerging Markets (LSE:FEML). Shareholders gave the trust the green light to change fund firm and how the trust invests. The trust can now short shares (profiting if a share price falls) and invest some of the portfolio in unlisted companies.

Nick Price, who has been lead manager of open-ended Fidelity Emerging Markets for more than a decade, is the new manager of the trust. Across both short and long time periods, the fund has outperformed sector rivals. Over three and five years, it has returned 50.2% and 82.2% compared to 26.6% and 51.6% for the Investment Association’s (IA) global emerging markets sector, figures from FE Analytics show. 

But, while shareholders backed the management change (voting 72.3% in favour), they do not appear to be a happy bunch. Ahead of Fidelity being handed the keys, investors were offered the opportunity to cash in their shares under a tender offer that was restricted to 25% of the trust’s assets. This was notably oversubscribed, with 85% of the share register taking up the tender, which was scaled down to the 25% maximum limit.

The trusts discount stands at -12.5%, which is higher than its  12-month average of -7.8%. In addition, it is the biggest discount in the emerging market trust sector, with the average discount being -7.6%. All discount figures, sourced from Winterflood, are to the end of trading yesterday. 

James Carthew, head of investment companies at QuotedData, points out that there’s a potential opportunity for investors to profit from the current discount.

He says: “We were surprised to see just how much of Fidelity Emerging Markets’ share register would have been prepared to sell out of the trust had the tender not been capped at 25% of the company. There is a clear implication that there is a substantial overhang of shares. Notwithstanding that, most of these investors seek to add value by trading discounts. They might be prepared to buy more shares in the trust at a wide discount with the intention of trading them out at a narrower discount in time. That should cap the downside.”

Proof, though, will be in the performance pudding. Existing and new investors could both be won over if, under Fidelity’s management, the trust delivers the same sort of sector-beating returns that are being achieved by the open-ended fund. Higher levels of demand should lower the discount. However, if performance disappoints, the discount is likely to remain stubbornly wide. 

Carthew adds: “We like the new investment approach, which makes good use of the closed-end structure to manage volatility and add some alpha by shorting stocks and indices. This is a style that has been used successfully by funds such as BlackRock Throgmorton Trust (LSE:THRG) and Schroder Asian Total Return (LSE:ATR) (although the latter doesn’t short individual stocks). We know that investors are prepared to look past the added complexity of this approach and embrace these trusts enthusiastically if they deliver results. Other trusts that went down this route, but didn’t perform well, withered and died.

“We think that the same is true of Fidelity Emerging Markets. If it generates good returns from the outset, new investors will be encouraged to buy the stock and, in time, the register will look more stable. Then, eventually, the discount will narrow. If returns aren’t up to scratch, the frustrated sellers on the register may soon agitate for another exit opportunity. For both scenarios, I’d watch to see how things shape up.”

Tweaking investment policy  

Another tactic that boards can use to attempt to boost demand and address a wide discount, is to fine-tune a trust’s investment policy. 

One trend over the past five years or so has been for trusts to introduce an enhanced dividend policy, funded from a combination of income and capital returns.   

Aberdeen Standard Asia Focus (LSE:AAS) could go down this road. Last week, it proposed increasing its dividend target by 100% to 32p per share. Other proposed changes to broaden the trust’s appeal to investors include a share split and a lower annual charge.

Hugh Young, the veteran investor, who has managed the trust since October 2018, told interactive investor’s Funds Fan podcast (published on 3 December 2021) that the proposed changes are an attempt to reduce the trust’s discount. He said the increased dividend will help the trust “appeal to the retail market more”. 

The trust has been a strong performer over the long term. Over the past 18 years, it has been the top-performing investment company in the Asia-Pacific Smaller Companies sector, with a total return of £11,601 on an initial investment of £1,000.

It has also produced higher returns than the two trusts in the sector over one, three and five years. Yet, it trades on a discount of -10.1%, slightly below its 12-month average discount figure of -11%.

Numis, the investment trust analyst, says: “Despite solid performance, the discount remains wide and it is positive to see the board proposing changes to attempt to improve the marketability of the trust, particularly with retail investors.”

However, Numis cautions that using some of the capital returns to fund an increased dividend is not a panacea.

It adds: “Increasing the yield on trusts has generally proved popular with retail investors, and in a low-yielding asset class, the use of reserves is becoming more widespread in the sector. In our view, it is important for investors to understand how a yield is generated rather than focusing solely on the absolute yield and any tax implications it may have.”

Joining forces

Another board that is eyeing up dividends is Scottish Investment Trust (LSE:SCIN). It was announced on 20 October that subject to shareholder approval the trust will merge with JPMorgan Global Growth & Income (LSE:JGGI). The proposed merger would give Scottish Investment Trust shareholders a 4% dividend policy and a change in investment approach, moving away from its current value-investing focus to a ‘style agonistic’ stance.

If shareholders vote through the changes on 9 December there could be a further reduction in Scottish Investment Trust’s discount. The discount, which stood at  -12.8% prior to the merger announcement, is currently -6.8%. Its 12-month average discount figure is -13.1%.

Discount control mechanisms

Another useful tool at boards’ disposal is the option to buy back their own shares to keep a discount under control. Under so-called discount control mechanisms, boards promise to purchase their own shares if the discount exceeds a certain level in normal market conditions, such as 10%. This can be beneficial for investors as, in theory, the discount will be contained.

Witan (LSE:WTAN) and Alliance Trust (LSE:ATST) are two standout examples of trusts that have been proactively buying back shares in 2021 in an attempt to protect their discounts, which are currently 7% and 8.9%. According to the analyst Winterflood, in the first 10 months of the year the duo have bought back a respective £123 million and £97 million of their own shares. Winterflood says that Witan targets a “sustainable low discount”, while Alliance Trust “protects [a] discount of 4.75% through buybacks”.

Only Scottish Mortgage (LSE:SMT), the UK's largest investment trust, has bought back more of its own shares – at £465 million.

Please note the author owns shares in Aberdeen Standard Asia Focus in a Junior ISA. 

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