The investment trusts with performance-linked escape routes

One of the many differences between investment trusts and funds is that the former have independent boards with a duty to act in shareholders’ best interests.

While it doesn’t happen often, boards have the power to change the fund manager or fund management firm running an investment trust. Arguably, the prospect of this keeps a manager more on his or her toes compared with those managers running an open-ended fund.

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Typically, boards only entertain making a change if performance hasn’t been up to scratch for a prolonged period. Often accompanied by substandard performance is a wider discount – when an investment trust’s share price trades lower than the value of the underlying investments, known as the net asset value or NAV.

As well as having this authority, there are other steps boards can take in an attempt to improve performance and keep shareholders onside.

One is performance-related tender offers. Breaking down the jargon, investors are offered an escape route if NAV performance undershoots a comparable index over a certain time frame.

Under a tender offer, a certain percentage of the share capital is made available to investors who wish to sell some of their holding. Tender offers typically offer exits at NAV or close to NAV. Therefore, this provides an exit route for shareholders at a better price.

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For boards, the attraction of such a policy is that it helps retain investors in the hope of improved performance, or the opportunity to exit in future at closer to the value of the underlying investments. Retaining investors also helps keep a lid on a trust’s discount.

A recent report from Winterflood, the analyst, estimates that 42 investment trusts now operate a tender offer or redemption policy. Just over half (22) have adopted “conditional tender frameworks”, offering a partial exit if performance falls short of a specific hurdle. The other 20 have unconditional tenders or redemptions, either on a periodic or one-off basis, which as Winterflood notes, provides investors with a more predictable exit route.

Since the start of 2024, 12 of the 22 investment trusts have introduced a performance-related tender offer, demonstrating a growing trend.

Five Baillie Gifford trusts offer escape routes: Baillie Gifford Shin Nippon (LSE:BGS), Baillie Gifford UK Growth Trust (LSE:BGUK), Baillie Gifford European Growth (LSE:BGEU), Baillie Gifford China Growth Trust (LSE:BGCG) and Pacific Horizon (LSE:PHI).

In the case of Baillie Gifford, Shin Nippon’s board has warned that performance needs to improve. Its one-off tender offer (of 15% of the issued share capital) will be triggered if the performance of its underlying investments (the NAV) fails to beat the MSCI Japan Small Cap Index over three years to 31 January 2027. In its half-year results, published at the end of last week, the board noted that at the halfway stage the investment trust is trailing the comparative index by 19.4%.

Jamie Skinner, chair of Baillie Gifford Shin Nippon, said: “I have been in regular communication with a number of ‘professional’ shareholders and have had correspondence with a number of ‘retail’ shareholders and, although there remains a loyal supportive base both of Baillie Gifford and Japanese small-cap growth equities, I am in no doubt that patience in some quarters is being tested. If poor performance continues into the medium term, then I do not believe that a 15% tender offer will be sufficient and the board will not hesitate to assess all available options.”

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Four investment trusts managed by JP Morgan have performance-related tender offers in place: JPMorgan European Growth & Income (LSE:JEGI), JPMorgan China Growth & Income (LSE:JCGI), JPMorgan Emerging Markets (LSE:JMG) and JPMorgan Global Emerging Markets Income (LSE:JEMI).

JPMorgan Emerging Markets’ tender offer will be triggered if the trust’s NAV total return cumulatively underperforms the MSCI Emerging Markets index over five years to June 2029.

Elsewhere, BlackRock, Aberdeen and Janus Henderson each have two trusts operating in this way: BlackRock Latin American (LSE:BRLA), BlackRock American Income Trust (LSE:BRAI), abrdn Asia Focus plc (LSE:AAS), abrdn New India Investment Trust (LSE:ANII), North American Income Trust (LSE:NAIT) and Henderson European Trust (LSE:HET).

The other trusts with performance-related tender offers are: Templeton Emerging Markets (NYSE:EMF), Barings Emerging EMEA Opportunities (LSE:BEMO), Scottish Oriental Smaller Companies (LSE:SST), Fidelity Emerging Markets (LSE:FEML), Schroder Japan Trust (LSE:SJG), Brown Advisory US Smaller Companies (LSE:BASC) and Vietnam Enterprise (LSE:VEIL).

Set to join the 22 trusts is Utilico Emerging Markets (LSE:UEM), which last month announced plans to introduce a new performance-related tender offer benchmarked against the MSCI Emerging Markets Total Return Index (its benchmark), and measured over a five-year period. If it fails to beat the index, it will tender up to 25% of its share capital at close to NAV. The proposal is subject to shareholder approval.

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Commenting on the growing trend of performance-related tender offers, analyst Winterflood says: “We view the introduction of tender offer policies as a prudent step by investment trust boards to address persistent discounts to NAV, which has been a consistent prevalent feature of the sector in recent years.

“These policies provide clearer exit opportunities for investors, offering a direct mechanism to realise value closer to NAV and improving flexibility compared to relying solely on secondary market liquidity. Importantly, tenders also serve as a market signal, demonstrating board commitment to discount control and providing a structured framework for capital discipline.

“Conditional tender offers also provide an added benefit of ensuring accountability to investment management teams by directly linking performance metrics such as NAV returns relative to benchmarks to corporate action.”

Share buybacks

Another tool boards can use to try to contain and reduce discounts are share buybacks.

By reducing the number of shares in circulation, there’s less of an imbalance between supply and demand. In theory, this will reduce the trust’s discount, benefiting shareholders as the share price receives a boost as it narrows towards the value of the trust’s underlying investments.

For investment trusts with a discount control mechanism – a rule to stop a discount going over a certain percentage – share buybacks are often used. 

While buying back shares is a sign of confidence from a board perceiving that the discount the trust is trading on is unjust and too cheap, it’s no panacea. Buybacks won’t prevent discounts widening if there’s 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. For investment trusts that are failing to attract investors but carrying out share buybacks, this leads to shrinking assets and less liquidity for the shares in the future.