Why do ITs buy their own shares?

grey_gym_sock

aroominyork wrote: »

Greygym, I do not see how an IT buying back shares affects the NAV. The NAV relates to the underlying companies' shares held by the IT so what difference does it make to the value of those shares whether, once bought by the IT, they are held by me in my portfolio or by the IT in their treasury?

shares which have been bought back are usually "held in treasury", but that's a detail - shares in treasury are not relevant for calculating NAV.

buying back shares at a discount will reduce the number of outstanding shares in the IT (excluding shares held in treasury), and also reduce the underlying companies' shares held by the IT, but it will reduce the latter by a smaller proportion than the former - which increases the NAV per share.

e.g. suppose an IT has 100 million shares outstanding, and holds shares in other companies worth £100m, so the NAV is 100p per share.

now it buys back 1 million shares, for 95p per share, so it has to pay out £950,000. it pays for that by selling £950,000 of shares in other companies.

so now the IT has 99 million remaining shares outstanding, and it holds shares in other companies worth £99,050,000. that makes the new NAV c. 100.05p per share.

Thrugelmir

Buying back own shares could be considered a better investment policy than simply holding "cash" or reinvesting the money into new holdings in a climate where many shares are trading at stretched p/e ratings.

aroominyork

OK, greygym, got it - except I don't agree that holding them in treasury is a detail. There is surely a fundamental difference between 1) buying back shares and holding them in treasury which means none of the underlying companies' shares are sold, the IT pays for the buyback from its reserves, holds on to them and the NAV is unaffected, and 2) your example of the IT buying back shares, selling the underlying companies' shares and the NAV increasing in the way you describe. In the case of TEM, they are doing the former.

grey_gym_sock

holding the shares that have been bought back in treasury does not imply that the the underlying companies' shares have not been sold. the £950,000 cost (using the figures in my previous post) of buying back the shares will result in a £950,000 reduction in the overall net assets of the trust, however they fund it.

i was oversimplying a bit by supposing that the trust's assets consist entirely of underlying companies' shares, with no cash held, and no borrowings. so perhaps the trust starts with £98m of underlying companies' shares and £2m of cash, and it funds the buy-back by reducing its cash. or perhaps it has £110m of underlying companies' shares and a £10m overdraft, and it funds the buy-back by increasing its overdraft.

but this doesn't make any difference to the NAV calculation. in any case, if the IT starts with £100m of net assets, and uses £950,000 to buy back shares, it ends up with £99,050,000 of net assets. and the share count (excluding treasury shares) has reduced from 100 million to 99 million. which boosts the NAV.

the treasury shares don't form part of the NAV calculation, because they don't own any of the trust's assets. they are zombiefied shares, which aren't currently active. if they are reactivated in the future, then that will be in return for their new owners paying in some cash, increasing the trust's assets again, and that will need to be at a price close to the NAV of the active shares at that time - which could be 200p or 50p - it's irrelevant that the shares were previously bought back for 95p.