14th February 2025
We have both read and heard (via conversations with Boards and brokers and other stakeholders), with increasing alarm, the view that “discounts do not matter”…. Or are “less important than Saba Capital has made out”… Or that (current) “shareholders don’t mind”…. Or some variant of that sentiment.
I’m afraid we unequivocally believe discounts absolutely DO matter, and the kind of thinking that does not place enough importance on them is outright dangerous and undermines the long-term health of the sector.
It is undeniably true that NAV returns over time often dwarf potential gains from narrowing discounts (or losses of widening discounts). It is also true that discount volatility is even more harmful than the presence of a discount.
However, as we have repeatedly bemoaned – especially when discussing why we rarely participate in them – investment trust IPOs launch with shareholders required to pay a c. 2% premium to NAV. The fees associated with IPOs are almost always paid for by day one shareholders via a NAV lowered by these costs.
Contrast this with the IPO process for equities of commercial companies. Day one investors are involved with the process and contribute to the pricing discussion. It is a given that day one investors need to be incentivised to back the IPO with attractive valuations.
For investment trusts, investors are often not only asked to pay £1 for 98p, but this is often a blind pool of cash, which the investment adviser then must execute on to purchase the assets required to fulfil the trusts’ objectives. After transaction costs, that 2% premium can quickly grow as NAV is eroded further.
To state that discounts don’t matter is to completely ignore the IPO process and forget about the crucial day one investors. It cannot be right that a discount, however constant and invariable, be allowed to be seen as “normal”. Imagine being told a 15% discount is about right 2 years after paying a 2% premium at IPO?! Or not to worry because NAV returns will eventually render the 17% loss minimal? Why would I ever back an IPO?
We firmly believe that a healthy investment trust sector is one that can allow a steady stream of IPOs. For that to happen, we cannot allow a culture of complacency to develop. Discounts should be regarded as temporary aberrations that Boards and investment advisers do everything within their control to reduce. Of course, we know that discounts can’t be completely eradicated, and there will always be some cyclicality, and some ebbing and flowing of supply and demand.
For those trusts with portfolios of liquid assets, there is simply no excuse for persistent discounts. For such trusts, the discount is a sign that it may not be relevant or making best use of the structure. Discounts are a function of excess supply or deficient demand. If there is not enough demand to drive a trust to a premium (assuming Boards are doing all they can on the supply front) then it surely fails a relevancy test.
For trusts with portfolios of less liquid assets, Boards must clearly set out plans that are aimed at reducing those discounts.
Meanwhile, new sources of demand must constantly be sought. Wealth management and fund buyers have retrenched – many permanently. We have previously suggested DC pension funds should be courted with alacrity.
Cries of “buybacks don’t work” miss the point completely. Buybacks are not working because there remains not just insufficient but falling demand. Indeed, if one believes that some levels of discount in sectors such as infrastructure, renewable energy and private equity trusts are permanent, how will we ever have an IPO in those sectors again?
The saddest thing about the current state of the sector is that it should be enjoying a golden period. Daily dealing property funds showed the importance of liquidity matching. The Mansion House compact, and the Labour Government’s pre-election commitment to economic growth, should have placed the investment trust as THE vehicle to channel private capital into infrastructure, smaller companies and renewable energy. Instead, the sector has been beset by a poor cost disclosure regime, falling demand from a consolidating wealth management sector and, potentially, complacent thinking around discounts.
Regardless of their motives, or how they have gone about their campaign, we believe that Saba Capital is right in one vital respect: discounts absolutely do matter.
Ben Conway – Head of Fund Management
For professional advisers only. This article is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. FPC25283.
