Investment trust liquidity myth exposed
JP Morgan’s David Barron says that, contrary to popular belief, closed-ended funds have a variety of tools at their disposal to convert assets into cash, including tender offers and C-share issues.
By David Barron , JP Morgan Asset Management
Thursday June 21, 2012
The issue of liquidity is often raised when referring to investment trusts, however to a large extent the concerns raised by advisers are overstated.
Liquidity is specific to each trust and there are sophisticated mechanisms in place to ensure that it can be controlled.
An investment trust’s board can take action to boost liquidity by issuing new shares, and can also repurchase them if demand drops.
This action is at the board’s discretion and can be suspended if market conditions are volatile, a benefit not available to an open-ended fund.
Understanding liquidity control mechanisms:
- Conversion share (or C-share) issue – conversion shares allow new shares to be issued while protecting existing shareholders from dilution. The C-share portfolio trades separately for a specified period before being merged with the main trust. C-shares are then exchanged for a proportional number of ordinary shares depending on the NAV of the two portfolios.
- Share buyback – investment trusts can buy back a proportion of their existing shares, helping them to narrow discounts by reducing the number of shares available in the market.
- Tap issue – investment trusts can issue new shares at a premium to the net asset value (NAV) to meet demand.
- Tender offer – an incentive offer to shareholders to buy back shares, usually at a narrower discount than the prevailing price.
- Treasury shares – shares that have been repurchased can be held in treasury with the potential to reissue them at a future date.
While the uptake among IFAs remains relatively low, private client wealth managers have been long-term supporters of investment trusts.
These intermediaries are comfortable holding large positions in investment trusts on behalf of their clients, both in monetary terms and as a proportion of the overall fund.
Liquidity does not appear to be a problem for these investors. The long time horizon of most investors means that they can comfortably place instructions to buy and sell shares over several trading days if needed. And if wealth managers can do it, why not IFAs too?
David Barron is head of investment trusts at JP Morgan Asset Management. The views expressed here are his own.