24th September 2021
We are often rightly interrogated by clients about our use of investment trusts. Of particular focus is whether we get concerned when the trusts we own trade on large premiums (or is it “premia”?) to their net asset values (NAVs). The implication is that the trusts are vulnerable to de-ratings. There is also a question as to whether holding such trusts conflicts with our investment process (which always looks for a margin of safety).
Our answer is that we are always wary when investment trusts that we own in the Funds start trading on premiums. We are soothed when we believe the NAV is fundamentally undervalued or “stale”. Less liquid asset classes are often valued only periodically, and so the “live” NAV can be higher than the last reported NAV, making live premiums illusory.
BUT, there are occasions when this dynamic works against us and we have to be constantly vigilant. We are aware of the conflicts of interests that exist in the broker / shareholder / investment manager relationship. When there is a successful investment trust that is in growth mode it can be very frustrating when that trust raises equity at a big discount to the prevailing market price, but still at a premium to their last reported NAV. This causes the price of the trust to fall too close to the price at which the trust is raising money. The broker wants the trust to raise as much as possible – and thus to raise at as low a price as they can get away with. We can’t blame them. Fees from secondary trading are dwarfed by fees on primary business. The investment manager wants to run a bigger trust: their fees are on net asset value. The stock argument used to justify this behaviour to existing shareholders is that we benefit from owning a trust that is bigger and more liquid with a lower OCF.
This is all well and good – and to be expected. We keep an eye on when investment managers might be likely to issue equity – for example by tracking how quickly they are investing the cash from the last raise. The problem is when the issue price is far closer to an old NAV and at too wide a discount to the prevailing market price. It may well be accretive to existing shareholders based on the old NAV, but we believe it is often dilutive as the NAV is understated in the first place. It is immensely frustrating that existing shareholders are treated like this and especially poor when the equity raise carries no pre-emption rights. (By the way, pre-emption rights definitely aren’t the solution – we care about the position size in our own Funds, not our percentage holding of the trust).
The investment trust sector is issuing a huge amount of paper currently. We are inundated. We are starting to turn down meetings as it is time to start sending a message that enough is enough. We are also making sure that we make the investment managers of trusts and their brokers aware of the damage they do when they issue shares at too large a discount to market price. We suspect that the large discounts that recent raises have been done at is a function of how much paper is being raised in the sector currently. Boards and investment managers need to know that we will mark their cards and we are less likely to be loyal shareholders of trusts that are consistently guilty of this behaviour. Our job is to protect our investors and that is something we will do fiercely and without apology.
Ben Conway – Head of Fund Management
This financial promotion is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. HA4551.