10th May 2024
Last summer we wrote a series of articles titled “We need to talk about investment trusts” which discussed why discounts were so wide, and offered some recommendations on how to narrow those discounts. Given the lower demand for investment trusts, due to a number of reasons, including the long-running OCF issues, institutional selling of UK assets and more attractive yields on offer from cash and government bonds. It is encouraging to see a noticeable pick up in corporate activity within the sector. Whether due to their own initiatives or under pressure from shareholders, investment trust boards have recognised they need to do more, both in terms of ensuring their respective trusts remain relevant in a new investment environment, leading to strategic reviews and M&A, and helping to address demand/supply imbalances, illustrated by record buybacks.
In Winterflood’s latest monthly note, they highlight the record level of buybacks this year. In April, there were £620m of buybacks, a whopping 152% increase when compared to April 2023 level. Indeed, since Scottish Mortgage announced its accelerated buyback programme in March when it promised to buy back £1bn worth of shares over the next couple of years, it has already bought £500m worth, including £313m worth on Wednesday this week which represents one of the largest single-day buybacks in investment trust history.
But even more encouraging was to see that the number of trusts doing buybacks has increased to 118 in April, representing the highest monthly figure since Winterflood’s records began in 1996, signalling good breadth across the sector rather than being concentrated in a small number of big names. Year to date buybacks have totalled £2.2bn, double the equivalent period last year. We have long said that buying back shares is less about being a silver bullet to narrow the discount and more about good capital allocation – buying your own portfolio on a wide discount can be a highly accretive investment, particularly on a risk adjusted basis, and should be the hurdle against which alternative uses of capital are assessed. Perhaps this is best illustrated within the infrastructure sector where all trusts have moved to discounts having traded most of their lives at premia allowing them to issue equity and invest in new projects. Today, most management teams and directors are actively selling assets, often at or above book value, validating NAVs that many investors don’t believe, and deploying the proceeds to repay debt and buy back shares.
When equity analysts pour over company quarterly earnings releases, the most important thing seems to be whether the company has beaten or missed expectations. While updated NAVs, earnings per share and dividends are equally important for us when looking at the results, we are just as interested to read about directors’ attitude to discounts and if there are any changes in capital allocation. The term ‘strategic review’ is cropping up in more results lately with a number of Real Estate Investment Trusts (REITs) recognising they are sub-scale and can’t see a way out of the entrenched discount. Although a number of mergers have taken place in recent months, simply putting two discounted REITs together won’t immediately solve the discount problem as it doesn’t reduce the supply. However, in a new world where the minimum market cap for most institutional buyers has increased, eventually they will appear on more buy lists and the discounts should slowly narrow. The well-publicised bidding war for Hipgnosis Songs is proof that if the assets are of good quality, they should garner interest if the vehicle in which those assets are wrapped trades at an extremely wide discount. Just in the last couple of days, the apparent hostile approach from the small Ashoka Emerging Markets Trust for the much larger Asia Dragon, provides further comfort that the current conditions are ripe for further corporate action.
According to Winterflood, the sector’s average discount (ex 3i) may have narrowed this year, from 16% to 14% (it was as wide as 18% in October and the alternative assets sub-sectors are much wider), it remains around the same level as when we wrote our articles lamenting the lack of action by all involved in the sector. Therefore, we believe there remains a compelling investment opportunity within the investment trust sector where the discounts remain wide and fail to recognise the sea-change in attitudes by all stakeholders in just a few months. Add in a potential resolution to the OCF disclosure rules and falling bond yields then this really could be the generational buying opportunity many, including us, have been shouting about.
Daniel Lockyer – Senior Fund Manager
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