A slippery slope for investment trusts with wide discounts
Investment trusts with wide discounts can use tenders and buybacks to close the gap. But these aren't a sustainable solution and don't produce the best outcome for investors.
Many investment trusts have become very rattled by the threat of activist investors and are concerned about reducing their discount to net asset value (NAV). This is mostly good: some boards had become too dozy about putting the interests of their investors first and more attention to structural discounts was overdue.
Still, it is also clear that many investment trust boards are convincing themselves that regular share buybacks and tender offers (an offer to buy shareholders' shares) are the best way to keep discounts down. As a shareholder in a number of investment trusts, I am far from convinced that this always produces the best outcome for investors like me.
The rules for investment trusts with wide discounts
Wide discounts can reflect a range of factors, including poor performance, doubts about the reported NAV, being in a sector that's out of favour, or the investment trust being too small and/or illiquid. Tenders and buybacks can do nothing for the first three: if the problem persists, you may need to change manager, change strategy, find ways to prove the NAV, or just wait for your market to become popular again.
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Meanwhile, the fourth scenario is why too many buybacks and tenders can even be actively harmful. They shrink the size of the fund, which will make it less attractive to many investors. Even an investment trust that starts at a healthy size can shrink itself into irrelevance if it gets hooked on buybacks and tenders in a vain attempt to control a discount driven by other factors. Consider Bellevue Healthcare (now CT Healthcare), which peaked at around £1 billion in 2021, but had dwindled to under £300 million by 2025, without really reducing the discount.
Who benefits the most from buybacks and tenders?
The other question is who benefits most from buybacks and tenders. Buybacks are at least accretive to remaining shareholders if the price is genuinely below net asset value. Still, I am cautious about trusts that decide to sell illiquid assets in weak markets to fund buybacks, because they may be selling the best assets and leaving the fund with the junk that is less likely to be worth its carrying value.
Since tenders typically happen near NAV, they are not directly accretive. True, long-term investors could take up each tender offer to the limit allowed, take the proceeds, and use them to buy shares more cheaply in the open market again – but many won't. So the beneficiaries here are often influential shareholders – activists or institutions – who want a chance to exit at a preferential price. If the discount does not then shrink and the trust becomes smaller and less viable, long-term holders have been left worse off by the whole process.
This does not mean that tenders and buybacks are always bad – but they need to be structured in a way that limits these disadvantages. A large exit opportunity every five years, perhaps triggered only if the fund underperforms, is fairer to all investors – not just those who want to cash out – than constantly shrinking the assets.
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