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Better returns on asset values

Professional vultures are moving in on trusts trading at deep discounts. David Prosser considers the pickings for small investors
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The pounds 52bn investment trust sector is having a rough ride. As a whole, it produced a 9 per cent return over 1997, not even half as good as the performance of the UK stock market. Worse, from managers' point of view, a group of opportunistic investors is circling the sector, picking on vulnerable trusts one by one.

To find the cause of the current crisis, go back to 1993. This was the height of investment trust popularity, so many managers launched a string of new funds or raised more money for their existing trusts. The mood was buoyant, with demand exceeding supply for many launches.

Since then, it's all been downhill. Most investment trusts, especially some of those new issues, have performed disappointingly. Even more damaging, the share prices of many trusts have slipped to wider and wider discounts to the value of their assets.

With too many investment trust shares in issue and prolonged middling returns, the situation became serious last year. The average trust discount reached 13.5 per cent, but that masked many discounts of over 20 per cent.

John Szymanowski, an SBC Warburg analyst, reckons something has to give. "Funds with mediocre performances, poor strategies and wide discounts are going to be picked off," he warns.

And that's exactly what has been happening. Several large predatory investors have taken big stakes in some of the weakest trusts and forced change. Their strategy is simple: if you buy assets at a big discount to their value and then make the trust take action to reduce that discount, you profit without the value of the trust's assets having to grow.

In fact, two types of predator are at work. First, stronger trusts, such as Scottish Value, have been buying into their weaker rivals and putting pressure on their boards. Advance UK, christened a "vulture fund" by many when it was launched last year, raised pounds 50m from investors backing this philosophy. Second, privately owned US companies, known in the industry as arbitrageurs, are pursuing a similar strategy.

Initially, the predators use their stakes to press the weaker trusts' boards into cutting discounts through restructurings, share buy-backs or conversions to unit trusts. If this doesn't work, they have several options, in some cases forcing takeovers or the replacement of a trust's manager.

In high-profile victories, the arbitrageurs have even forced Kleinwort Overseas and Fleming Far Eastern, two large funds, to close, selling their assets and distributing the proceeds to shareholders. In response to predatory activity, a string of trusts, including Baring Tribune, Broadgate, Continental Assets, Henderson Greenfriar and Overseas, are all preparing proposals to reduce discounts.

Not surprisingly, discounts have fallen as a result of all this activity. But Mr Szymanowski thinks the battle is far from over. "There's further to go" he says. "Performance itself is no longer a guarantee of survival. Not only must you perform, you must also keep your discount down."

Peter Walls, an investment trust analyst at Credit Lyonnais, agrees. "I think more deals will be announced even though there's so many already on the menu," he says. Mr Walls believes the opportunism of the predators, combined with the dissatisfaction of many smaller shareholders, will result in yet more rationalisation.

This is all good news for investors. Falling discounts will unlock the value held by many trusts. In some cases, restructurings and wind-ups have quickly released sizeable profits from trusts on wide discounts.

But be careful playing the game yourself. Small investors have less influence than the predators. And, as Mr Walls points out, poor performance negates the effect of lower discounts. "Buying on a 15 per cent discount is fine," he says, "but if you lose 30 per cent of the assets in six months, it's not very profitable."

David Prosser is features editor of `Investors' Chronicle'.