Do funding belief reductions even matter? | USAEMALL.com

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If you have an undesirable physical feature it is best not to harp on about it. Otherwise, you will become known as Bob With The Big Feet rather than Robert The Thoroughly Agreeable Fellow.

The UK investment trust sector appears woefully unaware of this common sense rule. Here, discounts are analogous to the feet that inspired jazz musician Fats Waller to exclaim “your pedal extremities are colossal!” An attack on the sector by US activist Boaz Weinstein has brought the insecurity into sharp focus.

Does it matter that investment trust shares typically trade at a discount to net assets? That issue is at the heart of Weinstein’s attempt to take control of seven UK investment companies.

He is taking a swing at the UK’s tight-knit investment trust industry via his business Saba Capital Management. He aims to supplant a series of board with two of his own candidates. The trusts would then replace their investment managers with Saba.

As a justification, Weinstein focuses on discounts — the sector’s not-so-secret shame. It is worth reminding ourselves what these are.

Investment trusts are closed-end funds. When investors trade shares, managers have no obligation to buy and sell underlying assets. This allows them to invest more easily in illiquid investments. But it means share prices are generally out of sync with net assets per share.

Usually, they are negatively out of sync. Discounts are typically 10-15 per cent. The higher figure is where they sit at present, if we exclude 3i, a large and unusually successful outlier, from the sample.

Discounts seem like a bad thing. Surely shareholders would be flocking to pay premiums for shares if investment managers inspired any confidence?

The reductionist view is that any trust trading persistently below net asset value should sell all its assets and distribute the cash, allowing shareholders to recoup the discount. This was what US activist Edward Bramson did at Electra, a trust specialising in private equity, after fellow investors voted him on to its board in 2016.

Discounts are therefore a perennial subject of anxious discussion in investment trust circles.

With the terrifying prospect of further activist incursions looming, investment trusts bought back a record £7bn of their own shares in the first 11 months of 2024, according to Morningstar data. The average discount increased anyway.

Suppose I buy into a trust at a 12 per cent discount and sell seven years later at roughly the same discount? The discount is a wash, as far as I am concerned

That is the problem with buybacks. There is little evidence they are effective. I had to scroll back to 2000 to find a study suggesting that a one-off buyback narrows the discount by an average of 3.2 percentage points after 42 days. This unimpressive effect may not persist.

Proponents say buybacks measurably reduce the volatility of discounts. So what? They are grasping for evidence and seizing the only inconsequential metric to hand.

Conventionally, business works very hard to downplay characteristics that embarrass them. Investment trust discounts are a curious example of an industry doing the opposite.

I find this puzzling. To me, discounts seem something of an irrelevance. Suppose I buy into a trust at a 12 per cent discount and sell seven years later at roughly the same discount? The discount is a wash, as far as I am concerned.

Plainly, I would do better if I bought at a steep discount and sold at a premium. But this is unlikely. The average discount on five out of seven of Weinstein’s target trusts has varied by, at most, 2.2 percentage points over three, five and 10 years to the end of 2024.

It is fair to point out that the average day-by-day discount for the whole sector has cyclically narrowed and widened by more than this over the period. But the cyclical element in discounts, which is currently high, cannot be blamed on individual managerial incompetence.

If I was a long-term shareholder in investment trusts, I would be more interested in total returns. The higher the returns, the less impact swings in discounts would have on them.

In this respect, Saba’s target trusts are a mixed bag. The CQS Natural Resources Growth & Income Trust has performed strongly over three, five and 10 years. The others have mostly lagged their benchmarks. Active managers generally do.

I do not save via investment trusts, because open-ended funds are a better, cheaper way to invest in liquid securities. If I did use them, it would be to gain long-term exposure to the illiquid assets which are now their forte. Discounts would play little part in my thinking.

Finally, how should shareholders respond to Weinstein’s overtures? All he has been promising them is returns of capital, and hopefully, better performance. His chances of delivering are no better than those of incumbent boards. As FT Alphaville has pointed out, a couple of investment trusts that Saba already manages trade at material discounts.

Independent shareholders in Herald Investment Trust saw Saba off last week. Investors in five other trusts would be well-advised to follow suit in polls next week.

Trust bosses are conscious of a deficit more crucial than discounts: voter apathy. Saba is set to hold a cash equities stake of around 29 per cent in each remaining trust. That is enough to win with over 50 per cent of votes cast if turnout among independent investors is some 39 per cent or less, even if none of them vote for Saba.

Keystone Positive Change is one of the target trusts currently banging the drum for shareholder democracy. Turnout at its last routine poll was 25 per cent.

Jonathan Guthrie is a writer, adviser and former head of Lex; jonathanbuchananguthrie@gmail.com