David Prosser explains why low single, single digit discounts appear to be the norm for investment companies at the moment.
Whatever happened to investment company discounts? Historically, the fact that investment company shares can sometimes slide to very substantial discounts to the value of the underlying assets has put some financial advisers off the sector. They worry that the discount issue is an additional headache to deal with, particularly during volatile times in the markets.
Here's the thing though. We’re right in the middle of one of those periods of volatility, yet discounts are barely moving. Yes, there are some funds where discounts have widened in recent months, but the average fund currently trades at a discount of just 4.3% according to the latest data from analyst Winterflood. That’s little changed since the beginning of the year, even though many leading markets have fallen sharply; the US alone is down 11%.
The experience of recent months provides further evidence that investment companies have got on top of the discount problem. There was a time, not so long ago, when the sort of turbulence we are seeing in the global economy and world markets would have propelled the sector as a whole comfortably into double-digit discount territory. But a new generation of investment boards has realised this is simply not acceptable to most investors and advisers – and they have taken action accordingly.
Indeed, Winterflood’s daily report on the sector includes a list of almost 40 investment companies that have been active recently in buying in their own shares, a strategy that tackles a widening discount head on. Some funds have made very significant purchases – Monks, for example, recently spent £3.1bn on a share buyback programme.
In many cases, investment companies now have discount control mechanisms enshrined in their constitutions. These mandate boards to start buyback programmes in the event that the fund’s discount breaches a set threshold – say 10%. At other funds, the policy on discounts is less formalised, with boards given more freedom to exercise their judgement; nonetheless, there is an expectation that the fund will take discount management seriously.
Opinion differs on the best approach. Some analysts believe a hard policy on discount control keeps the board honest, requiring them to intervene in pre-agreed circumstances. Others argue that this can encourage brokers and other interested parties to work against the fund in the knowledge that their shares will be bought in once the discount reaches a certain point.
The truth is that there is no one-size-fits-all approach that is right for this issue, not least because where the fund invests will have a huge impact on the likely range of its discount. Investors in an emerging markets fund, say, should expect more volatility than their peers holding blue-chip UK equities, including from the discount.
It’s also worth saying there are no silver bullets. There will inevitably be times when discounts spike. As the Covid-19 crisis broke in March 2020, for example, average discounts in the sector peaked at more than 21%. Still, what was noticeable about that experience was the way discounts came tumbling back down again just as quickly as they increased. Low single digit discounts now appear to be the norm for the sector as a whole.
In which case, this is not an issue that needs to trouble advisers any longer, at least for the most part. For intermediaries who once steered clear of investment companies for fear of having to explain discounts to their clients, it should now feel much more comfortable recommending the sector’s best funds.