Why you should pay attention when investment trusts raise new money
There was a time when buying into an investment trust public offering was a bad idea. But things have changed, says Max King. Investors need to keep an open mind.
The number of investment company IPOs (initial public offerings) has diminished over the years. However, the quality of these IPOs has increased, and is supplemented by a growing number of “secondary” issues (additional blocks of shares), usually offered at an attractive discount to the share price.
Sometimes these share offerings are available to direct investors through platforms such as Interactive Investor and Hargreaves Lansdown. But the private investor is often shut out, even when they are already shareholders.
The Stock Exchange imposes rules on “pre-emption rights” (the obligation to offer existing holders the first bite of the cherry) in secondary issues. But these restrict the terms of share issuance to non-holders rather than give holders automatic preference. These restrictions can be loosened by shareholders at large in a general meeting ie, by the big shareholders.
The good news is that small investors can now get around this.
Buying investment trust IPOs or share issues used to be a bad idea
The justification for shutting out small investors from secondary offerings is the additional costs involved in an offer to investors not classified by the authorities as “sophisticated.”
Less talked about is the reality that exclusion confers an advantage on professional wealth managers and investment funds, who get privileged access at a more advantageous price, helping them to justify their charges to clients.
Fortunately, there is a way into this cartel. PrimaryBid provides a platform which enables registered small investors to subscribe to new and secondary issues. They collect all the applications through their website and make a single application in the offering.
PrimaryBid does not have an automatic right to be included in the placing – but it would be very hard to justify shutting them out. You can learn more and sign up at www.PrimaryBid.com.
Of course, that doesn’t mean that all new offerings of investment trusts should be bought. Indeed, in the past, the presumption was rather the reverse. Share offerings accompanied temporary fashions in specialist areas such as privatisation, Latin America and Lloyds insurance.
When the outlook dimmed and the fashion abated, investors exited, the share prices sank to a discount to net asset value (NAV) and, in time, the trusts often disappeared. The larger the issue, the more wary investors learned to be – as exemplified by the £800m issue in 2010 of Woodford Patient Capital Trust.
But such scepticism is no longer justified. The average discount of investment trusts has fallen to very low levels, so there is much more secondary issuance, almost always at a premium to NAV. Some of this comes from “tap” issuance in the market according to demand, and some of it from the formal offering of a larger block of shares – perhaps to finance an acquisition for an infrastructure, renewable energy or property company.
Meanwhile the quality of IPOs has improved. Some of the “alternative” non-listed equity trusts have fallen by the wayside, but many have prospered and expanded and a few are approaching a size meriting FTSE 100 inclusion.
More significantly, some of the equity new issues have been hugely successful, notably Baillie Gifford American, Smithson, Schiehallion and Chrysalis, even when large (Smithson raised £822m in 2018). These trusts are (as of writing) trading respectively at 242%, 63%, 80% and 96% above their issue prices.
The quality of opportunity is getting better
To some extent, the reduced number of IPOs reflects saturation (investors would prefer the existing trusts to expand rather than back a new one) and to some extent, there is a size constraint, with an IPO below £75m unlikely to be economic.
But it also reflects an increasing number of trusts moving from one manager to another, whether on the same mandate (Temple Bar), through a merger (Perpetual Growth & Income) or on a changed mandate (Witan Pacific to Baillie Gifford China).
Last year, there were just eight investment company IPOs, raising £1bn, down 21% from 2019. The average since 2008 is 15 IPOs, raising £2bn a year, and the peak was in 2006 with 92.
But IPOs accounted for just 12% of the total of £8.4bn raised which, despite the market turbulence, was only 11% down on 2019. More surprisingly, total issuance by equity funds rose from £2.2bn in 2019 to £3.4bn, while “alternative” issuance fell from £7.2bn to £5bn.
Of the £7.4bn of secondary issuance, £3.2bn, including nearly all the equity issuance for the year, was “tap” issuance in the market as opposed to formal offerings at a fixed price. “Tap” issuance does not discriminate against the small investor to the same extent, as the price is much closer to that at which existing shares are traded in the market. By keeping the premium at which the shares trade down, it even helps the small investor get a better deal.
IPO issuance is expected to be muted in 2021 although a couple are on the slipway. But secondary issuance should be high, assuming that markets are less volatile. Many trusts are trading at a premium and ambitious to grow while appetite among investors is strong.
Broker Numis points out that more than half of new issues put out in the last ten years are trading at or near to NAV, while those on larger discounts have not necessarily performed poorly in absolute terms.
According to Numis, while 255 of the 326 funds launched between 2000 and 2010 no longer survive, 124 of the 163 launched since 2010 have survived with their original mandate intact. It looks likely that, by 2031, the attrition rate of the 2010-2020 vintages will be a lot lower than of the 2000-2010.
While the best strategy for IPOs, secondary offerings and for trusts changing managers and/or mandates was once “wait and see” before investing, investors should now be much more open-minded.