The best ways investment trusts should spend their cash

With share price pressures failing to go away, investment trusts have seemingly pulled out all the stops to win over investors. Some are winding down, others are merging and a few are undertaking strategic reviews to decide their future. As we’ve seen with names such as Hipgnosis Songs Fund (SONG), failed continuation votes are in some cases forcing boards to come up with some form of solution.

Elsewhere, because wide share price discounts to NAV have persisted even trusts without such problems have big decisions to make, whether on how to try to please shareholders or on investment issues. Share buybacks have been a common sight over the past year and recent examples include Greencoat UK Wind's (UKW) decision to spend up to £100mn on such a measure.

But trusts have plenty of other ways in which they can put their capital to work. They can buy back a large chunk of shares via a tender offer, introduce or increase a dividend, pay down debt, or simply invest their cash in assets. While the latter option might seem like the most obvious thing for an investment fund to do, there are plenty of other ways for trusts to deploy their assets. The best way to allocate capital will ultimately depend on a trust’s circumstances.

Tackling debt

As with personal finances, one priority can be to pay down debt, especially if it is expensive. Mick Gilligan, head of managed portfolio services at Killik & Co, notes that his preference for trusts with floating rate debt is for them to pay it down, given how expensive it can be in an environment of rising interest rates.

“Infrastructure trusts have typically used floating rate debt facilities to finance acquisitions,” he says. “This debt would then be paid down by a subsequent equity raise. Now it is no longer an option as raising equity at a discount does not make sense given how dilutive it is to existing investors.”

He adds that paying down debt more generally can help to prevent certain problems, such as a trust being forced to sell or write down assets, or cut dividends. Such measures can be especially helpful in cases such as that of Hipgnosis Songs, or if trusts have expensive debt or need to refinance soon.

Analysts at Stifel recently pointed to the potential for leverage to become an issue among some of the renewable energy infrastructure trusts, arguing in late October that "concerns about debt structures at a time of rising interest rates and worries about a possible credit squeeze" had been detrimental to share prices in the sector. They warned that a number of trusts need to refinance a good proportion of their total debt by the end of 2026, including Octopus Renewables Infrastructure Trust (ORIT), JLEN Environmental Assets Group (JLEN), Aquila European Renewables (AERS) and Greencoat UK Wind. However, much of the debt taken out by trusts in these sectors is fixed rate and their dividend cover levels tend to be healthy at the moment.

Buybacks versus tenders

With share prices low, retiring equity can be accretive for a trust while also helping to tackle a discount or stabilise a share price – at least in the short term. There are two different ways to do this: a buyback, which involves a trust buying back shares over a period of time, often on an ad hoc basis and a tender offer, via which a trust acquires a given proportion of its available shares. The latter is often done in difficult circumstances such as when a trust fails to meet certain performance targets over a given period.

Daniel Lockyer, senior fund manager at Hawksmoor, thinks that tender offers provide greater clarity. “A buyback clears up loose stock in the market [but] can be a bit piecemeal over a longer period and no quick fix, whereas a tender is good if there are shareholders who want to exit and they can get out," he explains. With a tender offer "in one go you have a rotation on the shareholder register [and] the register is immediately in better shape as you no longer have shareholders just hanging on to sell their shares.”

Following Greencoat UK Wind’s decision to do share buy backs, Stifel analysts recently commented that they prefer tenders as a “cleaner” way to return capital to shareholders. But there is one major drawback in that a tender can be a larger measure which requires more cash. So a trust needs to either have a good chunk of cash ready or hold assets which are liquid enough to sell quickly to finance the tender offer.

“If a trust is sitting on a material amount of cash, say more than 10 per cent of NAV, this represents a meaningful cash drag [so] a tender offer probably makes more sense as it should reduce the cash drag and enhance NAV more quickly," says Gilligan. But "if the cash level is relatively low, buybacks are probably more feasible.”

However, buybacks can also encounter problems. For example, Capital Gearing Trust (CGT) recently warned that it would temporarily limit its buyback activity because of an accounting issue and the need to reclassify its share premium account as distributable reserves.

There are concerns about whether trusts with illiquid portfolios can consistently maintain a buy back programme as they have no easy way to quickly sell assets and raise cash. So the balance sheets of trusts in illiquid asset sectors, such as private equity and infrastructure, should be carefully scrutinised when they consider such measures.

Dividends

Dividends have also continued to draw attention for good and bad reasons. Princess Private Equity (PEY) ran into trouble last year thanks to currency hedging costs and the withdrawal of its dividend sent the share price crashing. More recent instances include Hipgnosis Songs and Digital 9 Infrastructure (DGI9) canning dividends in the face of financial pressures.

This raises the difficult question of whether a dividend is sustainable. If a balance sheet shows strain – as with expensive debt – it could cause problems, while Lockyer warns to watch out for complicating factors such as the hedging issues which hit Princess Private Equity. It can instead be worth looking at whether a trust’s debt is not too expensive so can be repaid using portfolio revenues, and the extent to which the same applies for any dividends. You can assess a trust's level of dividend cover, and whether there are any portfolio issues and the effect these might have on a payout. This is hard to assess, though we recently outlined some sectors where analysts have cause for concern (Under pressure investment trust dividends, IC, 27.10.23).

In recent years, many trusts have introduced the ability to fund dividends out of capital. These include a number of equity funds such as JPMorgan Global Growth & Income (JGGI) and some other JPMorgan-managed trusts. And some names which invest in less liquid areas have also done this. For example, in the Private Equity sector, Apax Global Alpha (APAX) pays a dividend and HarbourVest Global Private Equity (HVPE) recently announced that it would consider distributing some cash generated from asset sales to shareholders via a dividend.

But it is important to remember that a dividend funded from capital can fall if a trust's portfolio struggles and potentially dry up if liquidity vanishes in tough markets.