Investment trusts - pointless?

Glen_Clark

Ark_Welder wrote: »

I would rather buy into the right assets to do the job at a premium, rather than the wrong ones at a discount.

Wouldn't we all.
But picking the right assets without the benefit of hindsight can be very difficult.
Picking a trust at a discount is easy

Thrugelmir

Glen_Clark wrote: »

I hold Graphite for some Private Equity exosure. The management take 2% a year in charges, and thats a lot, but its on a 23% discount. So you buy £100 worth of assets for £77. If the discount is still 23% when you sell them you will still only get £77. But, in the meantime, 100% of the earnings are going into the fund, which goes some way to paying the high management charges.
I also feel that if you buy a trust at 23% discount there is a better chance of that discount narrowing, (so you get more when you come to sell) than if you buy a trust on a 23% premium - paying £123 for £100 of assets because the management have had a good run and are temporarily in favour. This years star performer is often next years dud, and vice versa.

I hold GE as well (first bought at floatation). Valuation of unquoted companies is an imprecise science. As there's no liquid market for the shares, also valuations can be out of date. So personally I deduct 10% off the discount to allow a margin of comfort. Buying when discounts widen to over 25%.

Ark_Welder

Glen_Clark wrote: »

Wouldn't we all.
But picking the right assets without the benefit of hindsight can be very difficult.
Picking a trust at a discount is easy

Buying a growth asset at a discount, but which generates little or no income, isn't going to do the job of providing a reliable income. Buying an income-generating asset that is at a premium is more likely to meet that objective. Nothing to do with hindsight, everything to do with matching an asset to an objective.

A_Flock_Of_Sheep

I hold EDIN (Now on 5% premium)

JLIF

HGC

SOI

EZJ

bowlhead99

Ark_Welder wrote: »

[devil's advocate mode]

Just to use the example above. If Graphite is trading at a 23% discount, and HICL Infrastructure is on a 14% premium, which is the better investment?

[/devil's advocate mode]

I'll bite...

The market has priced each of them at a level that the participants in the market believe is appropriate. Therefore neither is the 'better' investment, but is likely their returns will differ over the next few years as they have entirely different strategies. Depending what you think the UK/European (and in Graphite's case, to a quite small extent, the US's) economy and markets will do, you may prefer to hold one or the other or both.

If you could pick up an investment in HICL's nice safe reliable infrastructure stuff for 23% discount, or even 0% discount, many would pile in. Particularly with bond prices where they are (high), and blue chip income stock prices where they are (high), you should not be able to pick up a portfolio of solid income-paying investments in hospitals, schools, transport infrastructure etc at a discount to the value of those assets. Unless the portfolio was very badly constructed.

So, people pile in until the price reaches something considered 'fair' which in this case means NAV +10.

By contrast, if you had to pay NAV+10%, or even NAV +0%, for a large portfolio of unlisted private companies:

- whose NAV has been determined with some difficulty by reference to price/earnings comparables of listed companies, or discounted cashflow projections, or infrequent private funding rounds;

- which are typically held for capital gain rather than producing visible income, and;

- the vast majority of those companies are held through a variety of investee fund manager's private funds who would not be intending to sell most of them for several years and on a timescale you can't predict;

- while each of the managers require you to honour your outstanding unfunded commitments to them for their pipeline of future deals over the next 1-5 years on a timescale you can't predict;

- with the unfunded commitments representing a quarter of your NAV (and the currency mix of your unfunded commitments not matching the currency mix of your existing assets);

You wouldn't typically pay NAV or NAV +10 for that unless the market was really bullish. So the price would fall to something more typical for the listed private equity sector, which has been a discount of 20%+ since early 2008 (discount of 60% at the absolute bottom of the market in '09) with fund-of-funds having a typically larger discount than the average.

So, the fact that a mix of illiquid private businesses with funding and return cashflows well beyond your control ends up being priced at a discount to what those companies would fetch if they were liquid and reliably priced on a market where you could sell them tomorrow, is not particularly unusual.

And the fact that infrastructure assets are in great demand, when FTSE has recovered to 6600 despite a generally poor economy and all fixed income opportunities are priced close to their all-time high, is also not unusual.

One can only conclude that each of these investment trust opportunities are priced reasonably sensibly for the type of assets the trust represents, the record of the manager and the current prevailing market conditions.

As it happens I'm not buying either at the moment (I'm not buying much of anything) but the track record of long term private equity returns is undeniable as is the case for buying solid infrastructure assets when equity markets are at something other than low points. Both of these investments, or their sector rivals - I'm not going to stick my neck out and try to say which trust might be the 'best' PE opportunity or Infra opportunity - could have a place in a portfolio even though they are 'alternatives' to traditional public equities and bonds.

gadgetmind

Ark_Welder wrote: »

It tells me that you looked at it before answering!

Nope. I bought VOD in two chunks, and both times because new money went into the portfolio and VOD came tops in my top-up/add strategy.

Several hundred quid in VOD divis dropped into the account yesterday, and as long as this shows no sign of changing, their NBV can do whatever it likes.

It was much easier years ago before the advent of discount control! The level of discount in the PE sector now was at times the norm for some generalist sectors.

Many still don't run effective discount control and have discounts that refuse to narrow. I find it hard to see this as being a bad thing!

I think that this is a strategy that works better when a sector is at a premium or discount rather than within a sector. At the sector level, it is an indication of sentiment towards that area. But a single trust at a discount to its peers is usually a signal that something isn't right - which may present a speculative opportunity, in itself, but deeper investigation would be a must.

Agreed.

Avoiding an IT that is at a premium when compared to its peers can also backfire, a case being AAS, as mentioned on another thread: it traded at a premium for around 12 months, moving back to a discount recently. Anyone that waited for the discount to return would have had to pay 50% more than the last time it was at a discount

Yes, but they could have held their nose and sat in an open-ended fund in the same sector for the period.

This is why I don't see the discount/premium as always being a priority concern: I would rather buy into the right assets to do the job at a premium, rather than the wrong ones at a discount.

Other than in specialist areas, my view is that there are always alternative ways to buy assets rather than via a high-premium IT.

Of course, I am a Yorkshireman ...

Ark_Welder

bowlhead99 wrote: »

The market has priced each of them at a level that the participants in the market believe is appropriate. Therefore neither is the 'better' investment.

Thank-you. And along with the rest of your post, exactly my point.

[edit] P.S. ...but the manner in which you have phrased it is beyond my fingers' ability to type!

bowlhead99 wrote: »

As it happens I'm not buying either at the moment (I'm not buying much of anything)

Apart from a certain amount of (self-) enforced activity on the SIPP, cash is probably my favourite asset right now.

gadgetmind wrote: »

Nope. I bought VOD in two chunks, and both times because new money went into the portfolio and VOD came tops in my top-up/add strategy.

Several hundred quid in VOD divis dropped into the account yesterday, and as long as this shows no sign of changing, their NBV can do whatever it likes.

Which is selecting an asset to meet an objective, and regardless of other data. Just for info, VOD is around a 35% premium to NBV, and NG around a 175% premium, which is lower than some other utilities.

gadgetmind wrote: »

Yes, but they could have held their nose and sat in an open-ended fund in the same sector for the period.

But they would have received an inferior return in doing so - even with Aberdeen's equivalent OEIC.For me, this shows the benefit of investing in a fund run by a company is which I have confidence rather than buying into one that is 'cheaper', and using the type of fund that I find tends to deliver the better return over longer periods. For completeness, the OEIC has delivered the better share-price return (i.e. to the investor) over 6 months and less - but that ain't much of a holding period!

Milarky

Investment trusts were invented before unit trusts with lumps of start up capital - hence their 'closed' investment structures.

The way I understood the existence of discounts and premiums (to NAV) is that when the shares trade at a discount the 'manager' receives the benefit of that in terms of higher 'earnings per share'. IF the manager simply distributed those earnings pro rata there would be no reason for the discount (e.g. ten percent more divi for the same share price?) to persist and it would be gradually removed by the share price rising.

But the managers may want to establish a consistent (say, above inflation) trend in divi payments independently of short term underlying earnings. So they'd hold back (that is set an historically below earnings) dividend and this 'certainty' is achieved at the cost of lower share price

But as you can buy cheaper and will therefore sell cheaper, the discount to NAV only effects someone (long dead) who invested the original capital - not current investors.

grey_gym_sock

investment trusts do generally (if they pay dividends) keep back a little of the income received on the investments held by the trust, so that they can smooth their payment of dividends - i.e. use their reserves to avoid cutting their dividend even in a year when the trust's income drops.

but even if they didn't do this, trusts could still go to a discount.

clearly, you can gain or lose capital value if a trust's discount narrows or widens while you hold it.

if you buy a trust at a 10% discount and sell at the same discount, then you neither lose nor gain capital value on the discount fluctuating. but you do get higher dividends while you hold the trust. e.g. if it is paying dividends worth 3% of its NAV, then that would look like 3.33% to you, a gain of 0.33% per year.

Ark_Welder

Milarky wrote: »

The way I understood the existence of discounts and premiums (to NAV) is that when the shares trade at a discount the 'manager' receives the benefit of that in terms of higher 'earnings per share'.

The fund manager doesn't receive a benefit from a discount - although that answer might lead to a discussion over the theoretical benefit of receiving fees based upon net asset values rather than share prices.

Where the fund itself can benefit, and therefore the existing shareholders, is when new shares are issued at a premium to NAV, and existing shares are bought below NAV and cancelled. i.e. discount control mechanisms in action. This may have an indirect benefit to the manager if their fee is based on the net assets of the fund and the size of the fund increases.

Milarky wrote: »

But the managers may want to establish a consistent (say, above inflation) trend in divi payments independently of short term underlying earnings. So they'd hold back (that is set an historically below earnings) dividend and this 'certainty' is achieved at the cost of lower share price

Retaining earnings might have the opposite effect and lead to an increase in the share price. If they are of a sufficient level to top up a shortfall in revenues in the future, then the increased 'certainty' over the level of the dividend (where 'certainty' should definitely not be seen as a certainty...), then it might make the holding the shares more attractive, rather than less.

Milarky wrote: »

But as you can buy cheaper and will therefore sell cheaper, the discount to NAV only effects someone (long dead) who invested the original capital - not current investors.

:cool: I have, on occasion, been accused of being overly inanimate (or is it underly?). There have even those expressing wishes towards myself, alluding to a certain state of being. But the last time I checked, I was still what might be termed, ante mortem.

...and still a holder of shares bought at the IPO. In this respect, a discount would mean that my return wouldn't have matched the NAV, but neither does it necessarily mean that I have made a loss, because both the share price and NAV could have increased since then - just at different rates.

Newer investors can also be affected by a discount. Regardless of the difference between the price at which a share is bought and the NAV at that time, the instance of that purchase is that investor's zero hour, i.e.their own starting point. And from there, they are in a similar position to those that buy at IPO.

Take bowlhead's example Herald IT from earlier in the thread. It could be bought at a 20% discount in 2009, and could be sold at a 20% discount today (I'll stick with the original figure!). So that individual has received a return that is in line with the NAV return: they have neither benefitted from the discount narrowing, nor have they suffered from the discount widening further -the latter being something that does happen, and sometimes forgotten about when 'buying discounts'. If the discount today was 14% rather than 20% then the investor would have received a return that is greater than the NAV return. But if the discount had widened to 25% then their return would have been less than the NAV return, just like a purchase made at IPO where the shares subsequently trade at a discount.