“People who have worked in the City long enough know that things are good now but at some point the cycle will turn. What are they going to do when that happens? It could be buying back shares. Whatever they decide to do is fine but boards have to be clear what their policy is towards managing discounts.”
While some are happy to buy back shares to protect tight discounts, even if it is to their detriment, others in more illiquid asset classes choose not to defend their vehicles.
Foreign & Colonial, for example, has spent a considerable amount in trying to target a discount of more than around 7.5% of its net asset value.
Another, more extreme example of this practice is Personal Assets, which adopts a zero-discount policy: the board buys back shares whenever they trade at a discount and issues shares when at a premium to hold a tight range.
Sayers says boards have become much more hands-on in addressing this issue, with the range of discounts narrowing significantly over the years. A 13% swing during the financial crisis was relatively small compared with the historical average because of board action.
“Boards are more proactive. They have not always had the powers to do it, so it is a relatively recent phenomenon,” he says.
“There were tax reasons that meant they could not buy shares as late as 1999. Discount control mechanisms are in their teenage years now – people have tried different things, some have worked and some have not – and boards are still ironing out the difficulties, but in most cases overall they have been a good thing.”
What other trends should investors be looking out for over the next few years in the closed-ended space?
One interesting development is the re-emergence of gearing, with several trusts having recently taken on long-term debt at low rates, such as Bankers, Murray International and RIT Capital Partners.
Sayers says: “The danger, people might say, is increasing more risk but I would ask new or prospective investors in this sector: what do you think equity markets on average will return over the next 20 years? If you say less than 3.5%, what on earth are you doing buying an equity fund? That is the level we are securing borrowing at.
“I suspect you will look back at this in 10 or 15 years’ time and see that now is the perfect time to borrow.
“After the financial crisis it was hard but now there is a willingness to lend, and we are at a point where interest rates are still low enough to borrow.”
As of the end of May, the average gearing across all sectors was 6%. Among the sector averages, UK All Companies was 3%; UK Equity Income was 9%; UK Equity & Bond Income 10%; and Property Direct UK an outlier at 21%.
Sayers expects the overall average to move closer to – though not exceed– 15%.
“A lot of trusts have old debentures that are unwinding anyway, so they are replacing these with new borrowing. I think it will be in relatively mainstream funds, either rolling over old debt or putting new debt in, though not at a massive amount.
“Still, if you are down at 5% gearing, what’s the point? It will not make a big difference, so between 10% and 15% is a more natural level.”
