Investment trusts - pointless?

Glen_Clark

Ark_Welder wrote: »

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.

I can see how buying shares at a discount and cancelling them benefits shareholders. Even better would be to wind up the trust and return all the assets to shareholders so they got close to NAV. Indeed, if the fund management were working in the shareholders best interest, instead of their own best interest, they would wind up the trust when the discount is greater than, say, 20%.
But who buys shares at a premium to NAV when 'existing shares are bought below NAV'?

bowlhead99

Glen_Clark wrote: »

I can see how buying shares at a discount and cancelling them benefits shareholders. Even better would be to wind up the trust and return all the assets to shareholders so they got close to NAV. Indeed, if the fund management were working in the shareholders best interest, instead of their own best interest, they would wind up the trust when the discount is greater than, say, 20%.

If all the assets were disposed of in a fire sale they would not achieve NAV.

The accounting standards that they are required to follow will tell them that the unit of account for a shareholding of one of their assets on the balance sheet, is one ordinary share (because one individual ordinary share in ABC plc could be sold on its own for, for example, £2.63), and the fair value of the holding is, for example, 13 million shares times £2.63. However, the market might not support a disposal of £34m of shares in ABC plc without moving the market price for ABC plc while they are selling the first 12.999 million of them.

Similarly, but with more extreme illiquidity, if Graphite Enterprise Trust has some holdings in other funds which are structured as limited partnership interests with ongoing commitments to put more cash in over a period of several years, there is a disconnect between the underlying value of the assets and the realisable value of the assets that could be returned in a reasonable timeframe. Example, at December 2012 they had an interest in Vue Cinemas through a partnership operated by Doughty Hanson; this can be valued by Doughty or by them using a sensible methodology (price of listed comparable businesses, cash flow evaluations etc etc ) but they cannot access the value without waiting for a disposal and distribution from Doughty in a few years time.

As it happened, Doughty sold Vue to some Canadian pension funds this June, which I presume has resulted in some cash back by now or will do soon. In the absence of this happening, the alternative solution would be to sell their entire partnership interest in the Doughty fund to a secondary purchaser for say 80% of the latest reported NAV.

So, it is not always straightforward to access value with which the shares can be purchased to reduce discount, or indeed to liquidate the whole thing.

That is precisely why investment trusts are useful for certain investment strategies, because if Graphite was an OEIC and excuse the pun some oik wanted to pull his cash out, they would have to get the cash from a quick fire sale of something. This would be terrible for Graphite where even on the stuff that Graphite manage themselves rather than going through independent fund managers, they can't sell £1000-worth of their interest in the Groucho Club; similarly if an infrastructure fund owns some European or US toll roads or a real estate fund owns a shopping centre, you can't just pull out a million's worth to meet redemptions. A large liquidity fund would need to be maintained which is a performance drag.

Also, buying back shares at a discount to NAV is not necessarily a good use of the trust's cash if the alternative is to utilise the cash to double its value in a nice time period which is what the investors are paying you to do, rather than just take a quick 10% and be out of cash and unable to fulfil your investment remit.

I'm sure you know all this but just for the benefit of others who may be more in the dark about what trusts can do or might do and why.

But who buys shares at a premium to NAV when 'existing shares are bought below NAV'?

What he was saying was that the discount control mechanisms can work quite effectively, because if you are trading at a premium you can issue a new share at a premium to NAV to soak up the demand (which is good for the NAV per share of all the rest of the shares in issue), OR if you are trading at a discount you can buy back some existing shares below NAV (which is good for the NAV per share of all the rest of the shares in issue).

So this is good for the trust and where it can be done liberally without detriment to the trust's investment portfolio objectives, the discount and premium can be kept in check quite well.

Of course if the cash from new share issues can't be deployed effectively to make the same IRRs as the rest of the portfolio, or the cash needed to run the buyback programme can't be easily obtained from the portfolio without increasing the risk of liquidity problems, it will not work so well, and some trusts do not engage in a lot of discount/premium management.

You are quite right that nobody would subscribe for new shares at a premium on the same day that shares were being bought back by the company in the market at a discount! Unless the new buyer is looking to buy a massive amount of new shares that simply aren't available in the market and would turn the discount to a premium in the course of his own buying.

IronWolf

Actually there is an investment holding company issuing new shares for 1.25 while they're quoted at 0.28 on the stock exchange.

Unsurprisingly I have a large amount invested in that one

Ark_Welder

Glen_Clark wrote: »

Even better would be to wind up the trust and return all the assets to shareholders so they got close to NAV. Indeed, if the fund management were working in the shareholders best interest, instead of their own best interest, they would wind up the trust when the discount is greater than, say, 20%.

Some trusts have a policy of putting this to a shareholder vote if the trust has traded wider than a specified discount over a period of time. But for some sectors that are prone to trade at wide discounts at times (such as PE) then winding up a trust might benefit short-term speculators, but not long-term shareholders.

In my view, PE is a long-term strategy to hold right now. Those trusts that have cash on their balance sheet should be in a good position to use that cash to buy into investments in the short term, which will benefit current shareholders who are investing for the long term. There may be dips in both the share price and the economy before then, but a dip in the latter is when that cash can be best deployed. And it is this that should ultimately be to the benefit of the current shareholder who is in it for the long term, both by the increase in NAV, and the closing of the discount that is likely to occur when other investors start to chase the returns. There have been realisations from some PE trusts recently, but the best returns tend to be made when economies are in good health and there are plenty of buyers for the trusts' investments.

Closing down a PE trust now would be like a shop that sells only snow shovels closing down because it isn't popular: it ignores that fact that its best returns are yet to come. No doubt the proceeds received from such a sale of the assets (at low prices) could be re-invested in the current hot favourite shop that is selling sun hats (or umbrellas?) - good for now, but not so good in the future. Well, that's my analogy!

+++

There is, or was, an attempt by one shareholder pressure group to get Graphite to introduce discount control. This has to be one of the most misguided ideas, one that shows little or no understanding of private equity. They claim that it is being done in the interests of shareholders, but it is something that is designed more to benefit carpetbaggers, i.e. those that pile in in the hope of a quick return and that have no interest in the long term. To be effective, Graphite would have to hold either cash or readily realisable assets, such as gilts, to be able to perform buy-backs to keep the discount narrow. Personally, I would rather a private equity fund manager deploy that cash into investments that will deliver a return rather than allowing it to be a drag on performance - this is where the long-term interest of shareholders lies, not in managing the discount.


P.S. Thanks, in advance, to bowlhead for any clarification that will be required to make sense of wot I 'ave writ...! :)

Glen_Clark

Ark_Welder wrote: »

Some trusts have a policy of putting this to a shareholder vote if the trust has traded wider than a specified discount over a period of time. But for some sectors that are prone to trade at wide discounts at times (such as PE) then winding up a trust might benefit short-term speculators, but not long-term shareholders.

In my view, PE is a long-term strategy to hold right now. Those trusts that have cash on their balance sheet should be in a good position to use that cash to buy into investments in the short term, which will benefit current shareholders who are investing for the long term. There may be dips in both the share price and the economy before then, but a dip in the latter is when that cash can be best deployed. And it is this that should ultimately be to the benefit of the current shareholder who is in it for the long term, both by the increase in NAV, and the closing of the discount that is likely to occur when other investors start to chase the returns. There have been realisations from some PE trusts recently, but the best returns tend to be made when economies are in good health and there are plenty of buyers for the trusts' investments.

Closing down a PE trust now would be like a shop that sells only snow shovels closing down because it isn't popular: it ignores that fact that its best returns are yet to come. No doubt the proceeds received from such a sale of the assets (at low prices) could be re-invested in the current hot favourite shop that is selling sun hats (or umbrellas?) - good for now, but not so good in the future. Well, that's my analogy!

+++

There is, or was, an attempt by one shareholder pressure group to get Graphite to introduce discount control. This has to be one of the most misguided ideas, one that shows little or no understanding of private equity. They claim that it is being done in the interests of shareholders, but it is something that is designed more to benefit carpetbaggers, i.e. those that pile in in the hope of a quick return and that have no interest in the long term. To be effective, Graphite would have to hold either cash or readily realisable assets, such as gilts, to be able to perform buy-backs to keep the discount narrow. Personally, I would rather a private equity fund manager deploy that cash into investments that will deliver a return rather than allowing it to be a drag on performance - this is where the long-term interest of shareholders lies, not in managing the discount.


P.S. Thanks, in advance, to bowlhead for any clarification that will be required to make sense of wot I 'ave writ...! :)

Isn't that what Severn Trent's Board said when they turned down £21 a share

bowlhead99

Ark_Welder wrote: »

P.S. Thanks, in advance, to bowlhead for any clarification that will be required to make sense of wot I 'ave writ...! :)

What you posted made sense to me.

Private Equity is a longer-term game than public equity which is one of the key strengths of the business model. The gross IRR that can be made from a typical 10-year fund can sustain a high level of ongoing management fees and large performance fees, so for both the manager and the investor, if you have a long term view, there is money to be made.

If you have been in fund-of-funds or many of the direct investing funds over the last year, much of your return will have come from discount narrowing due to a general re-rating of the sector rather than underlying NAV performance. This can't continue indefinitely and the discounts (or premiums for some - a small minority) are looking more sensible than they once were - so you should be careful not to misread short-term results (e.g. the last year's SP performance) as something to extrapolate forward.

I agree with your comments about trying to get Graphite to indroduce discount control being misguided in some sense (although I don't know the exact circumstances). While many listed PE entities have done share buybacks successfully - it is of course a NAV accretive opportunity if you're cash rich and priced at a discount - you are right that to have an ongoing policy of investing cheaply in yourself might result in forgoing investment opportunity.

Given that a manager with a strategy like Graphite's will have large unfunded commitments to other managers with unpredictable timing, on which it cannot reputationally afford to default, it can be difficult to know if the 'spare' half million today should be used to buy your own shares on the cheap or held in reserve. A large finance facility from a bank will help with liquidity - fund-of-funds will use something like that, effectively a huge overdraft, instead of a big pot of gilts. But in times of more expensive credit, or the credit crunch when it wasn't known how easy or difficult it would be to refinance or renegotiate the funding facilities, this wasn't something a fund of funds could afford to play games with, which is why you had some of them at 50%+ discounts and a perceived or actual threat of having to fire-sale some of their holdings.

All my PE investments are in fund-of-funds: HVPE, PIN and APEF. It's an inherently more expensive way to access the sector than if I had the millions required to get access to the underlying private investment partnerships, but the broad diversification across geography, industry sector, type and vintage year of investment is very useful if you just want broad exposure to this type of alternative investment.

A fund-of-funds trust holding an 'evergreen' portfolio of funds, where distributions received from some holdings on an ongoing basis allow it to pay the committed contributions to others over time, is a model that can work - as long as you have a broad portfolio and a decent enough liquidity facility from a bank to allow you to manage a period when the distributions dry up due to economic conditions (as they did a few years back).

By contrast, a listed fund making strictly direct investments off its own balance sheet has higher investment concentration and usually a greater problem of how to be ready to finance the next deal in an efficient manner (ie without having the IRR drag of a big cash reserve). It can be riskier and less efficient, even if the fee and expense exposure is perhaps lower.

So while a lot of the potential outperformance is diversified away by using funds of funds - I have exposure to a huge number or underlying PE managers and thousands of individual private equity deals through my holdings of the three trusts mentioned - I find it harder to use my sector allocation to buy into individual direct investors (despite the great potential if they get it right) and this means I have missed out on some stars like HGT.

But rather than the eggs in one basket approach of deciding that the guys at HG are going to keep doing well with their deals, I passively hold what I hope to be a set of quality fund-of-funds and let them ride for the long term (presuming there are no red flags in the fund reports or whatever I hear about the underlying investees from other sources).

APEF has introduced a policy of paying out some of its distributions received as dividends, which has probably helped with the discount, but I'm not actively looking for income out of this sector, more long term growth. For me they are sitting in a SIPP which can't be touched for 20 years and I might have 70 years left on this planet so no real need to take an income now, it would only get reinvested somewhere anyway.

For anyone who has not lost the will to keep reading yet, I saw this in the Investor's Chronicle last month which discusses PE discounts: here

Not a bad article although if you are new to the sector you might come away focussing mostly on the discount and share price side of things rather than what actual NAV returns these types of vehicles achieve. The table at the end of the article gives SP performance over 1,3,5 years for a smattering of vehicles in the sector and a confirmation of their current discount, but nothing of how that discount has changed in the 3 or 5 year time period or what the underlying NAV performance has been over time. On a long term view, its how the investments perform that will drive what you get out unless you are buying when the discount is very high or very low compared to longer term averages.

Actually another thing it does badly is the show ongoing charge ratio which is almost meaningless on some of the fund of funds. I mean 3i is showing over 6% and HVPE at 0.47%. HVPE will be paying management fees at the next level down in its structure (Harbourvest's fund-of-fund partnerships) and the level below that (the underlying fund managers, who hit them with annual fees of 1.5-2%+ on committed or invested capital and 20% performance fees if they achieve the IRR hurdles). Certainly you are exposed to more than 0.45% of NAV p.a. with HVPE, just like you are with 3i.

Ultimately, IMHO, it's NAV or price performance net back to the investor that matters, rather than fees per se, which I think many investors will appreciate, but this sort of table is misleading and may put off the type of investor who looks to IC for research rather than doing his own and is constantly hearing a message from index fund advocates that fees are everything.

Hmm. I appear to have gone off on a bit of ramble. Hope some of it was useful to someone, somewhere.... Now I think it's beer o'clock.
:beer:

Ark_Welder

Glen_Clark wrote: »

Isn't that what Severn Trent's Board said when they turned down £21 a share

What? They were thanking bowlhead for clarifying wot they 'ad writ too...?

Ark_Welder

bowlhead99 wrote: »

Not a bad article although if you are new to the sector you might come away focussing mostly on the discount and share price side of things rather than what actual NAV returns these types of vehicles achieve. The table at the end of the article gives SP performance over 1,3,5 years for a smattering of vehicles in the sector and a confirmation of their current discount, but nothing of how that discount has changed in the 3 or 5 year time period or what the underlying NAV performance has been over time. On a long term view, its how the investments perform that will drive what you get out unless you are buying when the discount is very high or very low compared to longer term averages.

I think that discounts are likely to narrow further in the next 6-9 months or so, for the simple reason that the credit-crisis crash will drop out of the 5-year performance figures. The share-price returns for some trusts will then look quite spectacular, so there might be an element of new investors chasing the returns. The NAV returns will look less spectacular, or just a lot less bad in some cases.

A similar situation to just over a year ago when the 3-year performance figures dropped the effect of the crash. Trustnet ran an article showing that PIN had returned 77% over 3 years - in share price terms. Over the same period, the NAV return was only 3%.

[edit]...unless something happens in the meantime and equities markets drop before then.

bowlhead99 wrote: »

Now I think it's beer o'clock.
:beer:

I'll be driving soon :mad::mad::mad:

But later, I won't be fit to drive a keyboard.

melbury

I have been paying a small monthly sum into Fidelity Special Values investment trust for about the past 10+ years and for some reason it is flying at the moment. Shame I hadn't put a bit more in per month:(

atush

That is part of life and investing.

But take into acct two things, you invested when you did and are making money so great, and you can increase your monthly investment amt if you want to.