Some trust boards have let down shareholders by allowing their discount to get out of hand, according Peter Spiller, manager of the Capital Gearing trust.
He said it was a major pet peeve of his when the share price on a trust surpasses the discount limit that board members had promised to maintain.
“My particular beef is when people have made commitments and then didn't fulfil them,” he explained. “Often, boards of directors say that if they do that then the trust will get smaller, to which my response is, ‘well that was true when you made the commitment, so what's changed?’”
“If you have made a commitment to shareholders, you have to keep that commitment to shareholders.”
Indeed, this particularly causes an issue today as the average trust discount spreads to an average 15.3% – almost as low as during the 2008 financial crash.
Average trust discount since 1990
Source: Kepler Trust Intelligence
Spiller said there is a risk here that these wide discounts become normalised, making it more difficult for trusts to regain a premium.
As an example, Spiller said a trust consistently selling at a 15% discount could set that as a new benchmark, making a 10% discount unattractive and causing investors to sell out.
With only 22 of the more than 400 trusts on the market trading on a premium, Ben Conway, head of fund management at Hawksmoor, said that the risk of discounts becoming deep-rooted is not being taken seriously enough.
“It is our belief that too few stakeholders are aware of how bad the situation has become and we are concerned that stakeholders with the wherewithal to impact the sector positively are either too complacent, unaware of the unintended consequences of their actions, or simply unaware of how serious the current situation is,” he said.
“At the heart of the problem is the increasing evidence that discounts are becoming entrenched.”
Trusts with a high volume of illiquid assets are vulnerable to wider market forces, so widening discounts can sometimes be unavoidable, but those investing in equities should not be trading as cheaply as they are.
Boards control the discount that a trust’s shares trade at and those in charge of equity portfolios have lowered the price to compete with open-ended funds, according to Conway.
“The discount [on illiquid trusts] is a reflection of a multitude of factors that may be outside the board’s control,” he explained.
“It is clearly in the power of boards [on equity trusts] to undertake some form of corporate event which might include liquidating part or all of the portfolio to buy back shares or to return cash to shareholders. Shareholders and boards simply should not tolerate persistent discounts in those trusts.”
By inflating the discount, Conway said boards are not only creating an environment where trusts become trapped below their net asset value (NAV), but are also neglecting their responsibility to shareholders.
Investor’s shares are worth less than the assets these trusts hold, yet few shareholders seem to be making their boards accountable, he added.
“The board should prioritise the interests of shareholders over the interests of the investment advisor, but there is plenty of anecdotal evidence where those priorities have been the wrong way round, but the presence of these persistent discounts is, in our opinion, hard evidence of sub-standard corporate governance within the sector over recent years,” Conway said.
“The inability or unwillingness of all shareholders to engage and hold directors’ feet to the fire has compounded the issue.”
Boards may have some responsibility for large discounts, but Spiller said corporate governance on trusts today is the best it has ever been.
As one of the industry’s longest serving managers – having run Capital Gearing since 1982 – Spiller has seen a lot of changes to board practices over the years.
“Corporate governance compared with when I first started out has improved by a country mile,” he said. “Boards typically feel much more responsibility to towards the people that matter, and that’s the shareholders.
“Nevertheless, the rules changed in 1999 to make all discounts voluntary, so I think it should be a fundamental principle that all boards address their responsibilities.”
Although boards control discount levels, sometimes selling shares at a sub-NAV level can be beneficial to a trust and its investors, according to Pascal Dowling, partner at Kepler Trust Intelligence.
“Against that backdrop, it would be foolish to suggest that investment trust boards – even if they have previously made a commitment to controlling the discount – should ignore the prevailing weather and seek to maintain a rigid discount to NAV,” he said.
“Doing so would require them to buy back shares – probably repeatedly as the medicine wears off each time - undermining the trust’s firepower and eroding its cost efficiency as the overall size of the trust shrinks.”