The big buyback

It is quite the statement of intent from Scottish Mortgage. The investment trust has announced plans to buy back up to £1bn worth of its shares over the next two years – the equivalent of 9% of its total market value on the day before it announced the buyback programme. It’s the most high-profile example to date of what has become a significant trend in recent times – share buybacks in the investment trust industry last year were up by more than 50%.

As with many of its peers, Scottish Mortgage’s buybacks are aimed at reducing the discount at which its shares trade relative to the value of its underlying assets. The fund was until recently one of the investment trust sector’s top performers, but struggled during the market conditions of 2022 and 2023, which did not favour its managers’ style. That shift has inevitably affected investor sentiment and hit demand for Scottish Mortgage shares. As a result, the fund was trading at a discount of around 15% before the buyback announcement.

The role of the board of Scottish Mortgage is to safeguard the interests of shareholders in the investment trust – its investors, in other words. Taking this action is part of exercising that duty, with the board hoping that investors’ shares will move much closer to a price that fully reflects the value of the fund’s assets.

Share buybacks certainly can be an effective way to get on top of discounts. Indeed, some investment trusts now have discount control mechanisms in place that require them to launch buybacks if their discount hits a certain level. The idea is that by reducing the number of shares in issue, you mop up the excess supply of stock, bringing it into balance with the current level of demand. This should see the discount narrow.

In practice, there are several advantages of buybacks. Whatever happens to the share price, the net asset value (NAV) per share of the fund will increase. Buybacks may also enhance the fund’s dividend yield. Also, shareholders wanting to exit the fund can do so without putting undue pressure on the balance between supply and demand for shares.

Still, it’s not all plain sailing. Share buybacks will, by definition, shrink the size of the investment trust. This can cause problems with liquidity – the ease with which investors can buy and sell shares – particularly for smaller funds. There are also fewer shares in total to shoulder the fund’s costs, so expense ratios may rise.

There is also the question of how the buybacks are financed. Sometimes, an investment trust holds enough cash to pay for the programme. But with larger buyback plans, including Scottish Mortgage’s, assets may need to be sold to fund the purchases. This may not be ideal.

Overall, however, most investment trust analysts are in favour of buybacks. And they do make a powerful point about where the power in an investment trust lies. Fund managers often dislike buybacks, which shrink the size of the fund – and therefore their fee income. Boards therefore have to be prepared to flex their muscles in support of shareholders. It is a good example of why, when boards do their jobs, the investment trust structure has such merit for investors.

In Scottish Mortgage’s case, by the way, the buyback programme has had an immediate effect. Just £20m or so into the £1bn programme, the fund’s discount has already moved from 15% to 8%; the market has clearly been convinced of the board’s determination on this issue.