Interest rate rises have triggered a re-pricing of all risk assets, which helps explain why investment trust discounts are at historically wide levels.
The average discount for the closed-ended fund universe is 16.5%. This compares to an average discount of 5.3% over the past decade, according to Refinitiv.
One tool that boards have in their armoury to try to contain or reduce discounts is through buying back their own shares.
By reducing the number of shares in circulation, there is less of an imbalance between supply and demand. In theory, this will reduce the trust’s discount, benefiting its shareholders as the share price will be given a boost as it narrows towards the value of the trust’s underlying investments.
Data from broker Winterflood shows that boards are proactively using this option. In the first seven months of 2023, buybacks are up 53% year-on-year, totalling £2.2 billion.
Winterflood points out that Worldwide Healthcare (LSE:WWH) tops the share buyback charts so far this year, having bought back £126 million. In second and third place are RIT Capital Partners (LSE:RCP) and Smithson Investment Trust (LSE:SSON), which have bought back £126 million and £117 million.
However, while buying back shares is a sign of confidence from a board, which views the discount the trust is trading on as unjust and too cheap, it is no panacea. Buybacks won’t prevent discounts widening if there is just no demand for the shares.
Much more important over the long term is the performance of the underlying investments held by the investment trust. This has the biggest influence on the overall total shareholder returns. Put simply, if the trust doesn’t perform well, it is likely to consistently have a high discount due to a lack of demand for its shares.
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Also, bear in mind that investment trust discounts typically have a greater tendency to converge to their mean discount rather than the value of their underlying investments.
Another trend is private equity investment trusts increasing share buybacks. The sector is currently out of favour amid scepticism over whether the valuations of unlisted companies, which are set behind closed doors, reflect the reality of what those assets could be sold for today in the higher interest rate environment.
Winterflood notes that three private equity trusts that have been buying back their own shares lately are Pantheon International (LSE:PIN), HarbourVest Global Private Equity (LSE:HVPE) and ICG Enterprise Trust (LSE:ICGT).
Prior to some private equity trusts stepping up share buybacks, there was criticism that the sector was not doing enough to tackle widening discounts.
In May, Investec's investment director Alan Brierley said: “To be candid, for many years, we have been underwhelmed by discount management in the Listed Private Equity sector. The typical modus operandi for too many companies appears to be to state that the discount materially undervalues the portfolio, express frustration about stubborn discounts, and proclaim that buybacks ‘don’t work’.”
However, as Winterflood notes, the share buybacks of late by some private equity trusts is a positive sign. Winterflood said: “If this is the starting signal for investment trusts to put their money where their valuations are, we strongly support the effort, as any prospective new investment should first clear the threshold of being more attractive than the current portfolio on a double-digit discount. Hence, this development illustrates the virtue of board independence in aligning capital management decisions with shareholder interests.”
Some boards are reluctant to undertake share buybacks because the overall size of the investment trust is reduced.
In addition, while share buybacks can influence discounts, they also increase costs for investors (although it tends to be minimal) in the process. That’s because when the number of shares in issue is reduced, the fixed costs of running the trust are spread across a smaller number of shares.
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