Should you buy an investment trust at IPO?

Many recent issues offer attractive yields which have been popular because of historically low interest rates and the cost of getting access to investments that already offer a good yield: a number of existing investment trusts in higher yielding sectors trade at premia to net asset value (NAV). Many of the new launches moved very quickly to a premium.

Recenti nvestment trust IPOs

Source: Morningstar, Winterflood

Recent examples include Fair Oaks Income Fund (FAIR) which listed on the Specialist Funds Market in mid-June and yields 4.9 per cent. It is already at a premium to NAV of 4.07 per cent. It has a dividend target of at least Libor plus 6.75 per cent and invests in collateralised loan obligations with a focus on floating rate loans.

P2P Global Investments yields 6.1 per cent and has moved to a premium of 6.6 per cent. It invests in peer-to-peer loans and expects to generate total returns of 5 to 15 per cent a year. At least 85 per cent of all income should be distributed as dividends, with the expectation that it will pay an annualised dividend yield of 6 to 8 per cent.

This could be an argument for getting in at the beginning. But analysts and investors have their concerns.

"When issuance is at a peak it is usually a sign that markets have overheated," says Jeremy Le Sueur, managing director of 4Shires Asset Management. "You should buy into areas after they have not done so well."

When you buy at an IPO, there are launch costs which are paid by the initial investors - so for example, for every pound you put in maybe only 98p gets invested, meaning you are in effect buying at a slight premium.

Charlie Murphy, listed investment companies analyst at Panmure Gordon, suggests you only buy an investment trust at IPO if there is not an existing one at a reasonable price. An example is the infrastructure sector where most trusts trade at high premiums, in some cases double digit ones.

Read more on when it is ok to buy at a premium

He says you also need to consider if the new trust is offering something new or compelling enough to risk the uncertainty of a new product. Existing trusts have a track record to assess and there may also not be as much information about new trusts as existing trusts.

"Always think about what you are buying and why," he says.

James Carthew, head of research at Marten & Co, says you should not buy an investment trust IPO thinking you are going to sell it quickly at a profit. He says you should consider it a long-term investment.

Before you jump into a new fund, Mr Murphy also says you should think about how it will fit into your existing portfolio and what it will do for it in the long term. For example, could it overallocate you to an area because you already have exposure there?

Peter Walls, manager of IC Top 100 Fund Unicorn Mastertrust (GB0031269367), suggests you don't buy into an asset class that has risen considerably, and to make sure the trust's managers are experienced and good at what they are doing.

If the fund invests in illiquid assets, it could take some time for the money to be invested. The new trust is unlikely to pay dividends from the start - this often happens in the second year - unlike when you buy a more mature trust on the secondary market. "Even if an investment trust is on a slight premium it may be more attractive because you receive instant dividends," says Peter Hewitt, manager of F&C Managed Portfolio Trust (FMPG), a fund of investment trusts.

The IPO prospectus should tell you when the trust expects to start paying dividends and at what level. Stephen Peters, analyst at Charles Stanley, says it is very important that you carefully read the prospectus if you are thinking about investing in an investment trust at IPO.

A new trust will also have not built up revenue reserves like some mature ones, which can draw on these to maintain or continue increasing dividends if the underlying assets do not generate enough income in a given year.

Many of the recent and forthcoming IPOs are focused on alternative or unusual investments, so you should be very clear about what you are buying, how it works and what the risks are. "With unusual assets it is hard to evaluate the long-term prospects where there is not a long-term investment record for that asset class," says Mr Hewitt.

Read more on unusual assets

Funds invested in assets which are hard to buy and sell might find it harder to control the discount, for example, via share buybacks. Although many are on premiums at the moment, market conditions could change, for example, a rise in interest rates could make high yielding esoteric assets seem less attractive. If interest rates move up - as has recently been indicated - investment trusts on high yields could move to a discount.

A successful IPO does not mean success in trading thereafter: while many recent issues have moved to a premium to NAV, Riverstone Energy (RSE) which launched last October raising £760m, the largest IPO of 2013, has moved to a discount of about 6.5 per cent and its share price has trended downwards.

Global Resources Investment Trust (GRIT), which launched in March this year, has moved to a discount of more than 16 per cent, while Globalworth Real Estate (GWI), which is focused on Romanian property and launched last year, trades at a discount of around 17.6 per cent. Neither of these trusts yet offer a yield.

However, even if the share price falls below what you paid in the short term, the underlying assets may have long-term potential, So with esoteric assets, in particular, you should have a long-term investment horizon.

Even if an IPO succeeds, there is no guarantee the trust will succeed in investing the money raised, in particular if its target assets are esoteric. GCP Sovereign Infrastructure Debt (GULF) did an IPO in December last year with the aim of investing the proceeds in subordinated debt issued by sovereign-backed infrastructure project companies, primarily in Gulf states. The trust expected to be fully invested within four to six months with an initial target dividend yield of 5 per cent, paid in November this year.

But due to transactions taking longer than expected in May, it revised down the dividend level to 3-4 per cent, and last week said it was considering its options because it has identified risks with its planned transactions of around $100m that would take them outside the scope of the trust's investment policy. This may impact its ability to deliver its dividend target over the long term, so it is uncertain if these investments will go ahead in the foreseeable future, and the trust is holding its shareholders' money in cash.

Options include winding up the trust. If this happens, broker Numis says that shareholders who have already paid IPO costs are likely to face further costs to wind up the company.

Retail investors

Even if you fancy taking the plunge, as a private investor with a smaller amount to invest than an institution such as a wealth manager, you may not be able to get into an IPO easily. Some IPOs expect you to buy a minimum value of shares which can be prohibitive, for example, £10,000 or more.

If the IPO is not what is known as an open offer, it might just be placed with institutions, so your only way in might be as a client of a private wealth manager. This is often the case with investment trusts focused on unusual assets or those looking for a listing on the Specialist Funds Market.

But as a private investor seeking smaller amounts of money than an institution, even if a fund is hard to buy and sell you will have less difficulty getting a small amount on the secondary market from your broker, though there might be a wide bid offer spread.

Forthcoming IPOs

Many more IPOs are planned this year in areas including property, infrastructure and distressed debt.

These include Franklin Templeton's Fondul Proprietatea fund on the Specialist Funds Market later this year. This was set up by the Romanian government in December 2005 to compensate people whose assets were expropriated by the communist regime by granting them shares in it, though currently the majority of shareholders are foreign institutions.

It has been listed on the Bucharest Stock Exchange since January 2011 and its share price has risen more than 60 per cent since launch. The portfolio is heavily weighted in the power, oil and gas sectors - approximately 90 per cent of NAV - through a number of listed and unlisted, privately-held and state-controlled entities.

Sniper China Logistics Properties is seeking £200m. It manages Sniper Capital, and also runs Macau Property Opportunities (MPO).

Read IC Columnist David Stevenson's view

Empiric Student Property (ESP) is seeking £110m and is expected to close by the end of this month. Liberty Living, due to launch this year, will also focus on student accommodation.

Read more on Liberty Living

Infrastructure Debt Fund is seeking £150m and its fund-raising is expected to close at the end of June. It will be managed by Australian firm AMP Capital.

Ingenious Clean Energy Income (ICE) is seeking £200m. It hoped to launch in March but is still looking to come to market.

In the equities area, Fundsmith Emerging Equities Trust (FEET) has been seeking £250m and attracted a lot of interest, so is expected to do a successful raising. It should launch on 25 June.

The trust will focus on companies with relatively predictable revenues, low capital intensity and which offer value on a long-term view. It will mainly invest in consumer staples in developing economies.

Fundsmith runs a global equities fund, but does not have a track record of emerging markets investing. Top fund manager Anthony Bolton who had a very impressive record with developed markets focused Fidelity Special Situations Fund (GB0003875100) between 1979 and 2007, started running an emerging markets fund, Fidelity China Special Situations (FCSS). This had a difficult start over the first two years, but in the latter half of 2013 the performance picked up.

Source: Morningstar

Despite this being Fundsmith's first emerging markets fund, managers such as Mr Hewitt and Mr Walls argue that the Fundsmith investment team is very experienced, and now could be a good time to get into emerging markets which are cheap but have long-term potential, although there could first be more downside to come.

Another equities trust due soon is Sanditon Investment Trust, which will be run by former Cazenove fund managers Tim Russell and Chris Rice. It will mainly invest in Europe, holding a concentrated portfolio of 20 to 50 shares. It will also invest a good deal of its assets in the asset manager - a similar model to Lindsell Train. This company runs IC Top 100 Fund Lindsell Train Investment Trust (LTI), which has about a quarter of assets in its manager.

Sanditon Investment Trust will also short shares - bet on the price falling - a hedge fund technique. Its managers, Mr Russell and Mr Rice ran an absolute return fund which used hedge fund techniques at Cazenove.

Sanditon Investment Trust has completed its raising and is due to come to market next week.