Personal Finance: Trust in us: it's not a wind-up
Saturday 26 June 1999
So do investment trusts have a future? Part of the answer to this may have been given last month when Mercury's European Privatisation Investment Trust (MEPIT) survived a break-up attempt . Speculators bought up almost 5 per cent of the shares issued by the pounds 1bn trust, arguing it had underperformed, and hoping to rally support among institutional shareholders for a wind- up. If successful, they stood to gain the difference between the price they paid for their shares, and the trust's underlying "net asset value" which represents the current market value of all the trust's holdings.
There is nothing new about "arbitrage" activity of this kind. It allows a very quick profit to be made as a result of two characteristics common to investment trusts.
Firstly , their share price is a function of investor demand on the Stock Exchange, not of the value of the assets that they own. This means shares in a trust can be bought at a "premium" when the price of the trust's own shares stands above its net asset value (NAV) of the shares the trust holds, or at a "discount" when the price stands below.
A second characteristic is that shareholders with more than 5 per cent of a trust can put forward a motion to wind it up at its annual general meeting. Around two thirds of shares in UK investment trusts are owned by institutional investors. Many of these are pulling out of investment trusts, and using their own fund managers to invest directly into the same assets.
"Offered the prospect of an immediate cash profit, some of these institutions will go with the speculators, unlike private investors who tend to be very loyal, keeping their holdings over the medium to long term," observes Ian Barby, head of the investment trust division at Mercury.
These conditions have created an excess of supply over demand for some types of investment trust share. Prices have fallen and discounts widened. Trust managers need to find new money, and the Association of Investment Trusts(AITC) is proposing a pounds 27m marketing plan aimed at private investors.
But investment trusts have proved less popular with us than alternatives like unit trusts. The result is a net outflow of capital, some pounds 1.6bn since 5 April from the sector as a whole. Meanwhile trust managers are trying to defend themselves by "buying back" shares in their trusts, aiming to reduce discounts and improve shareholder value.
MEPIT is a case in point. Its shares were trading at just 110p early last December, but now stand around 167p. Meanwhile the discount to the NAV has narrowed from 18 per cent to just 9 per cent. This makes it look as if the "arbies" did other shareholders a favour, but Mr Barby, is not so sure.
"The fund needed to change its investment remit, and we announced this was to happen two days before anyone knew of their attempt to break it up. We have also been buying back our shares, and this year will again buy the maximum permitted amount of 14.99 per cent. Arbitrageurs are out for short term profit, while we are catering to long term investment needs."
Not everyone agrees with this view. Jeremy Batstone of Natwest Stockbrokers thinks that, "the IT sector will shrink before it grows, and arbitrage is a stimulus to the poorer performing management teams, running trusts which lag behind their sectoral equivalents."
All of this opens up some tempting prospects for the private investor. Why not buy into trusts on wide discounts and wait for arbitrage to do its work? "Not that easy," warns Mr Batstone. "You must be very careful about the true NAV of a fund." To reach this, deduct the winding up cost which could be 4 or 5 per cent. So a paper discount of 10 per cent might in cash terms be worth only half that, equivalent to the bid/offer spread on a unit trust.
"Watch out also for the debt owed by a trust .Some sectors, such as property trusts, borrow over the medium term and must pay a cash penalty on early redemption if the trust is wound up." Institutional investors, with blocks of shares, are nearly always the key to whether a trust survives or is broken up.
Do investment trusts have a future? "Only the fittest will survive," says Mr Batstone, "but don't buy without first doing some serious research."
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