Discounts bring despair

Investment trust discounts have increased considerably in recent years, leading to concerns about prospects for the industry. In 1993, the average discount was 3 per cent, its lowest for 20 years. Now it is around 12 per cent, despite efforts by many funds to reduce discounts.

The increase is due to over- supply and under-demand. The number of trusts has increased and traditional investors have been selling, while demand for their shares has not kept up.

In 1993, investment trusts were booming. Many traded on narrow discounts and a few were at a premium. During that year, the FT-SE All-Share index rose 23 per cent while the average trust went up 46 per cent. This led to a glut of new trusts.

Before long, supply outstripped demand and discounts began to rise. The problem was compounded by lacklustre performance as many trusts invested in difficult areas such as emerging markets, rather than in British and American blue chips which continued to do well.

Sterling's strong performance has added to the problem, because many trusts have part or all of their assets overseas.

Efforts to reduce discounts include boards putting pressure on or sacking managers if their trust is not performing well. Elsewhere, boards have approved schemes to buy their own shares to try to reduce the discount, a recent example being Mercury European Privatisation. Govett Global Smaller Companies has announced plans to convert into a unit trust. This will eliminate the discount as unit trust prices are based on the value of the underlying assets and not stock market forces.

Other funds have merged. This happened recently with Edinburgh Japan and Dunedin Japan, while Henderson merged two trusts to form Henderson High Income. Predator activity has also increased. Scottish Value Management (SVM) has acquired large stakes in several trusts and then tries to persuade them to make changes or hand over the management.