Investment trusts are companies listed on the stock market and like other companies they are subject to corporate action which can have a beneficial effect on the share price. It is a quiet period for activist shareholders (known as arbitrageurs) as investment trust discounts to net asset value (NAV) are generally tight so there is not much opportunity for improvement. However, investment trust investors should always keep an eye out for arbitrageurs and other types of corporate action. We run through six common types of corporate action, giving examples of affected investment trusts, below.
1. Arbitrage activity
When an activist shareholder takes a stake in a company and it is perceived that they may effect positive change, or they enact some sort of change, this can help the price rise. Sometimes this is also the case with a merger or takeover, while the prospect of a cash return via a tender or wind down can also have a positive effect.
An example of this is Electra Private Equity (ELTA), the share price of which rose when activist investor Sherborne Investors Management started to increase its stake in February, which now amounts to 19 per cent of the trust's shares. It has taken no action but just the stakebuilding has helped push up the share price and considerably tightened the discount. However, this is not a typical example of the type of trust an arbitrageur targets, as Electra has a good long-term track record.
If activists on the register lead to the trust being wound up this can lead to disappointment for some shareholders if they wanted the trust to continue, and it had a good manager. "Your interests as a long-term shareholder are not necessarily aligned with activist shareholders who are short termist," says Simon Elliott, head of investment company research at broker Winterflood. "There will always be some investors who will get involved alongside activists and some have done well. But we are always wary of advocating that. You want to be aware of the shareholder register, but a trust may be on a discount for a good reason."
Alliance Trust (ATST) has been subject to a good deal of arbitrageur activity over the past few years. Currently, activist investor Elliott Associates, a US hedge fund, has around 10 per cent of the shares in Alliance Trust. Elliott has not stated its reasons for investing in this trust.
Alliance Trust is on a discount of more than 12 per cent, although it now conducts share buy-backs after implementing a programme in 2011 following pressure from another activist investor, Laxey Partners, which has since exited its investment in the trust.
2. Wind ups
A wind-up vote normally follows a prolonged period of trading on a wide discount. "The effect of winding up is for investors to get an exit for cash at NAV so it is a good chance to make a short-term gain," says Simon Moore, research team leader at Bestinvest. "But it is not certain that the vote for a wind up will be passed and the discount may widen out if it is not."
"A wide discount and the shape of the shareholder register may make it clear that the next continuation vote may not be passed, so investors need to decide whether an investment trust in this situation offers potential benefits," adds Nick Sketch, senior investment director at Investec Wealth & Investment. "There are many investment trusts that have looked good candidates for this situation but have nevertheless struggled on for years, so a dose of scepticism is needed."
Indian private equity trust Eredene Capital (ERE) is in tactical realisation. The shares in this trust fell after a port project it invested in did not proceed, although the trust held a portfolio of revenue producing assets. As a result, it is in realisation and its shareholders have so far received a windfall of 17.2p per share. However, the market fears that it will be difficult to sell the remaining investments so it trades at a discount to NAV of 51.8 per cent.
Trusts in wind down as at 25 April 2014
| Trust | EPIC | Discount to NAV (%)** |
| Alternative Investment Strategies | AIS | -2.84 |
| Ashmore Global Opportunities - £ | AGOL | -24.85 |
| Ashmore Global Opps - US$ | AGOU | -23.77 |
| AXA Property Trust | APT | -31.9 |
| Cambium Global Timberland | TREE | -36.91 |
| Candover | CDI | -27.98 |
| Duet Real Estate Finance | DREF | -3.48 |
| Eredene Capital* | ERE | -51.08 |
| European Real Estate | ERET | -41.17 |
| Global Fixed Income Realisation | GFIR | -42.09 |
| HarbourVest Senior Loans Europe | HSLE | -4.17 |
| International Oil & Gas Technology | OGT | -82.1 |
| Invista European Real Estate | IERE | -89.36 |
| LMS Capital | LMS | -11.04 |
| Mithras | MTH | -7.73 |
| NB Distressed Debt - US$ #*** | NBDD | -0.51 |
| Northern Investors | NRI | -9.5 |
| Private Equity Investor | PEQ | -21.96 |
| RENN Universal Growth | RUG | -10.05 |
Source: Winterflood, *Investors Chronicle, **Morningstar.
***Just a single share class that is in wind down. The Extended and Global share classes are not in wind down.
Some investment trusts have a defined life from the outset. This is not uncommon among split-capital trusts and towards the end of their life share prices can spike up, in particular in the case of zero dividend preference shares which make a payout at the end of their lives rather than paying dividends on a regular basis. Jupiter Second Split Trust (JSSZ) is due to wind up later this year and while its ordinary shares are on a discount of around 20 per cent, its zeros are on a 2 per cent premium.
3. Tender offers
"If an investment trust trades at a meaningful discount yet has a fixed life or offers a cash exit at a fixed date, then the additional performance that this will deliver (on top of whatever the portfolio generates) has to be considered," says Mr Sketch.
Meanwhile, tenders of returns of cash can considerably shrink an investment trust. Atlantis Japan Growth (AJG), for example, used to do three tender offers a year but has shrunk rapidly and only has a market capitalisation of about £50m. This makes it too small for a number of investors such as wealth managers to consider.
So last year the trust changed its policy to only do redemptions twice a year and introduced a limit on redemptions of 5 per cent of the issued share capital at the relevant time.
4. Share issues
Mr Moore says another beneficial situation can be when an investment trust issues shares. "This is usually done at a lower price than the current market price, so investors taking up this share issue will normally get a short-term gain," he says.
A share issue can widen the shareholder base and cause the ongoing charge to fall.
Trusts trading on a premium to NAV usually do this, examples including infrastructure investment trusts some of which are on double-digit discounts. Examples include IC Top 100 Fund HICL Infrastructure (HICL) which is on a premium of more than 15 per cent and in February raised £23m via a share issue.
Some property investment trusts, which are also on premiums, are doing this, too.
5. Continuation votes
Some investment trusts face continuation votes every so many years, or one can be triggered, if, for example, the discount falls below a certain level. This can create an opportunity for activist investors and sometimes they will move into a trust facing this, and this can lead to a tightening of the discount. Aurora Investment Trust (ARR) faces a continuation vote later this year and institutional investor Capital Gearing Asset Management has built up a stake of nearly 18 per cent.
"This is the sort of corporate situation where a trust is at risk of stake building," says Nick Greenwood, manager of fund of investment trusts Miton Worldwide Growth (MWGT). "However, in this case it has not really improved the price. But there is a much tighter discount compared with where it was at the end of 2008, when it was as low at 28 per cent. But it is not far off its long-term average of 13.5 per cent."
The trust trades at a discount to NAV of 15.7 per cent.
Aurora has not been helped by its stake in Asian Citrus (ACHL) because emerging markets have suffered recently. "But I think, while it is a bit battered, if the manager sticks to what he does it might do better this year," says Mr Greenwood.
6. Management and fee changes
Changing investment objective can also have an effect. Edinburgh Worldwide (EWI) originally focused on larger global growth companies but will now also be able to invest in smaller companies. Its discount has tightened considerably, moving in from a 12-month average of 8.05 per cent to 1.53 per cent.
"Proposed changes to fees can in some cases make an investment trust substantially more attractive, but changes to the investment policy or income yield will usually have a bigger impact on demand (and hence discount) as well as on future NAV returns," adds Mr Sketch.
More than 30 trusts changed their fee policy between the start of 2013 and end of 2014, according to Winterflood.
Meanwhile, if a good fund manager leaves an investment trust its share price can fall and the discount can widen, as for example happened when Richard Buxton stopped managing Schroder UK Growth (SDU). When Neil Woodford announced his departure from Invesco Perpetual and there was uncertainty over the future of IC Top 100 Fund Edinburgh Investment Trust (EDIN), this fell from a premium to a discount. This continues to trade at a discount because, although Mark Barnett has been named as its manager, there is still uncertainty on how he will manage with his considerably larger responsibilities.
Conversely, the appointment of a new manager can improve the trust's share price and tighten the discount to NAV, as happened when Neil Woodford was appointed to Edinburgh Investment Trust in 2008.
But targeting corporate situations can be a high-risk strategy. "A lot of people lose money by buying vulnerable trusts because, ultimately, you may still get underperformance and high fees," says Mr Greenwood. "We never buy a trust at a deep discount just because of that. If we are concerned about the asset quality we will usually avoid it." "You must really understand the investment and why there is a discount," adds Charles Cade, head of investment companies research at Numis Securities. "If there are portfolio problems the discount is merited." The main risk is that you buy into a poor performer and it carries on performing poorly, and there are not any corporate changes. A discount may also close but you still get continued underperformance. And corporate action is not guaranteed to close the discount. "If, for example, a trust has expensive debt and can't unwind this without a penalty the discount may not close, or if a trust breaks up the proceeds might not be as good as you thought they might be," says Iain Scouller, head of the investment funds team at Oriel. "Just looking at a trust because it had done badly and hoping for action can lead you into value traps," adds Peter Walls, manager of fund of investment trust Unicorn Mastertrust (GB0031269367), an IC Top 100 Fund. "I need to see another catalyst, for example a trust in an out-of-favour sector, which looks like it is going to change. Also be happy with the portfolio and the asset class." Getting in too late, meanwhile, means you may miss any uplift from corporate action and buy a trust at an expensive level which is not necessarily going to go further. But there are overall benefits for investment trusts. "Corporate activity has led to a healthy sector overall, although it is not always a good outcome," says Mr Elliott. "It is why the sector has outperformed the market in the long term, and a reason why investment trusts have beaten open-ended funds. The weaker ones are realised or wound up and that market efficiency is no bad thing."Risks of targeting corporate action
