Don't trip up on trusts: Maria Scott warns against inflated prices on investment trust shares

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The Independent Online
A NEW risk awaits the unwary buyer of shares in investment trusts. An increasing number of trusts have share prices higher than the net value of the assets they hold.

In simple terms, this NAV 'premium' means investors are paying over the odds for their shares. If the trust was to be wound up and the assets distributed, shareholders who bought at a premium would lose money.

Traditionally, investment trust prices have stood at discounts to asset value, and much has been made of this in promoting the trusts to small investors. About pounds 100m was committed to investment trust savings schemes in the first half of this year, almost as much as for the whole of 1992.

Premiums are appearing on some of the trusts most popular with small investors, such as Bankers and TR City of London, both managed by Henderson Touche Remnant.

Bankers stood at a premium of 1.8 per cent on Friday, against a discount of 4.55 per cent just over a year ago. TR City of London's premium has risen from 2.52 to 7.1 per cent.

Premiums are now common among trusts specialising in emerging markets. Templeton Emerging Markets, for example, stood at a 13.4 per cent premium at the end of the week, against a discount of 5.03 per cent a year ago.

UK income funds are also moving on to premiums as the likelihood of further interest rate cuts intensifies. Merchants, at 2.2 per cent on Friday, stood at a discount of 0.4 per cent at the end of July. Unit trust prices reflect the underlying assets in the trust's funds. For this reason, some advisers think it now makes sense to look again at units.

David McFadyen of Olliff & Partners, investment trust brokers, said: 'I wouldn't buy any of the emerging market investment trusts at the moment. They do not justify the premiums. I don't think the performance stacks up.' He admits, however, that he has an interest since Olliff also runs an emerging markets unit trust.

Robbie Robertson of County NatWest said premiums were not necessarily a reason for steering clear.

'Investment trusts that have gone to a premium are of a certain type - ones that have caught the public's imagination. There has been either excellent performance over the long term or a reasonable yield over deposits.'

The decision on whether to invest depended on the quality of investment management and the steps the trust managers took to stop the premium becoming over-inflated.

For example, Henderson Touche Remnant has started issuing new shares for the TR trust, to satisfy demand from its savings scheme.

The managers price the shares at a premium to the net asset value.

Mr Robertson explained how this works: 'Assume a trust has 100 shares in issue and the net asset value is pounds 1 per share. If 100 new shares are issued at 105p per share, the company brings in an extra 100 shares at that price. It then has an asset value of pounds 205. Divided between 200 shares, this gives an NAV of 102.5p per share.

'People buying the shares are putting assets into the company at a value higher than the NAV and effectively spreading that over all the shares. It has a value-enhancing effect.' The opposite is true if shares are issued at a discount.

Flemings also uses this system for its Claverhouse trust, whose shareholders are now almost entirely private individuals. Earlier this year, Flemings went further and issued pounds 22.8m of Claverhouse 'conversion' shares. These were not converted to ordinary shares until the money was fully invested in a new portfolio mirroring that of the existing Claverhouse fund. The premium dropped near to zero but has since reappeared.

A number of financial advisers have warmed to investment trusts in recent years. Kean Seager, managing director of Whitechurch Securities, is one. But he is becoming cautious now because of the premiums. 'I am happy to buy pounds 1 of assets at 80p, but not so happy to buy at pounds 1.10. Our monthly income portfolio is made up entirely of unit trusts now. All the funds we like in the investment trust sector are at NAV or above.'

One example is Value & Income, managed by OLIM. It stood at a premium of 7.4 per cent on Friday.

When a bear market arrives, says Mr Seager, investment trust prices may fall more heavily than unit prices as investors realise the shares are over-valued. The danger of this happening has grown as more small investors have moved into investment trust shares.

'People have to be a bit more careful in their selection of investment trusts,' suggests Mr Seager.

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