Personal Finance: Mercury hopes for second time lucky as investment trust savers run out of patience

The Jonathan Davis Column
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Indy Lifestyle Online
The latest buyback will help stop the discount from widening further, but it will be a long haul before the discount is eliminated If at first you don't succeed, then try again. At first sight that seems to be what Mercury Asset Management is trying to do with its European Privatisation Investment Trust (Mepit) as it, like nearly every other investment trust management company, wrestles with the problem of discounts in the sector.

The discount problem is one which I have mentioned before and appears to show no signs of going away, despite the best efforts of the management companies to stem the tide.

The average discount on all conventional investment trusts is still at around 12 per cent, close to the high for the year.

This is still well below the high levels of discounts that were experienced in the early 1980s, but the widening that has been going on for much of the past 18 months remains in place.

Discounts in the sector seem to be settling stubbornly in the 10 per cent to 15 per cent range.

Given the other pressures on the sector, including the threat of new competition from open-ended investment companies (OEICS), the option of sitting back and doing nothing is no longer feasible if you are a management company, which is why every major group is looking so hard at ways of trying to eliminate the discounts on their trusts.

The route that Mercury has been following with its Mepit trust has been to buy back shares in the trust. At the start of last year it announced a scheme to buy back up to 86 million shares.

Although it has not yet exhausted its authority under the original proposals, it is now having a second bite of the cherry by seeking shareholder approval to buy back a further 76 million ordinary shares.

It is also proposing to offer to purchase and cancel warrants that were issued with the ordinary shares at the time of the trust's launch in 1994.

A number of things make Mepit of particular interest in the debate about the outlook for discounts. One is the trust's size.

With a market value of around pounds 700m, the trust is one of the largest in the sector.

Another is that it has an excellent track record. Unlike its ill-fated counterpart, Kepit, run by Kleinwort Benson, which was put out of its misery not so long ago, its performance record has been consistently good since launch.

The net asset value has grown more rapidly than its main benchmark, the MSCI Europe index, and is up by around 80 per cent since its launch in March 1994, against roughly 55 per cent for the index.

It has a sensible mandate - there are perfectly good reasons to believe that European privatisation issues will do well as an investment theme for the current decade - and it is run by one of the best fund management houses.

All in all, this is a trust that would seem to have excellent prospects.

It underlines the fact that the discount problem is primarily a generic one for the sector, not a trust specific issue.

Mepit's discount is currently at 13 per cent, which is not as bad as it has been, but still disappointing for those who bought at the launch, as many private investors did.

It was one of the most popular investment trust launches.

The shares are up by around 44 per cent since launch, but a good number of the original retail investors have since sold their shares to search for better performance elsewhere.

Will this new scheme work? It is not fair to say that the original share buyback scheme has failed to do any good. Loughlin Callahan, who runs Mercury's investment trust operation, is able to point out correctly that in relative terms Mepit's discount position has improved since the first scheme was announced.

While the average investment trust discount has widened from 8 per cent to 13 per cent since the first scheme was launched, Mepit has not suffered the same fate. Its discount has remained broadly in the same range. But since its discount was wider in the first place, that is a minor consolation.

It is symptomatic of the efforts that management companies are now making to try and resolve the discount issue that Mercury, like Abtrust and M&G before it, are having to come up with imaginative schemes which require court approval before they can be implemented.

My guess is that the latest buyback will help to stop the discount from widening further, but it is going to be a long haul before the discount is eliminated. The recent launch of two more "vulture funds", which aim to try and force underperforming trusts to do better, on pain of being wound up or taken over, is a powerful incentive for change in the sector, but my view is that there will be no real let-up in the discount until the current surfeit of investment trusts is rationalised further. The fact that even a high quality trust such as Mepit is having to run so fast is a sure sign of that.

A footnote on the active versus passive management debate. Research by WM, the performance measurement consultants based in Edinburgh, underlines the consequence of aiming too high with your investment objectives. It found that only 20 per cent of those pension funds which were set a target of beating the main market index by 1 per cent a year were consistently able to do so over five years. "There is little point in active management," says WM's research director, Gordon Bagot, "unless you believe it is possible to outperform the index by a greater margin that that required to pay the additional fees for active management." Quite so.