Why share buybacks give back value to shareholders
David Prosser delves into what happens when trusts buy back their own shares.
Investment trust discounts remain wider than many investors would like. Shares in the average investment trust currently trade at a discount of around 12% to its underlying assets – narrower than we’ve seen in recent years, but still at a level with which may feel uncomfortable. And some trusts are on much larger discounts.
Take a look at the data on share buybacks and you might find this surprising. After all, investment trusts bought in £10.2bn worth of their own shares last year, more than in any other year in the industry’s history. Most of those buybacks were aimed at tackling discounts – the logic is that by reducing the supply of shares available in the market, you should achieve more of a balance with demand; that should bring the price closer to the value of the fund’s assets.
More than 40 investment trusts running buyback programmes raised net asset value per share by more than investors were paying in fees to the funds’ managers.
David Prosser
Share buybacks often work well. Analysis published last month by stockbroker AJ Bell looked at the five largest investment trust buyback programmes last year – each one succeeded in bringing down the discount. This is one reason why many investment trusts have introduced discount control mechanisms, where they are obliged to automatically consider buybacks when the discount reaches a certain level. Research from Winterflood Securities say 79% of investors value this approach.
Still, buybacks aren’t a panacea. When an individual fund is out of favour, buybacks may not be enough to overcome the negativity. Sometimes, entire fund sectors – or even the whole investment trust industry – lose their appeal to investors for a time. In periods of heightened risk and volatility, say, investors may retreat; share buybacks may reduce supply, but they don’t necessarily conjure up extra demand. Investment trust shareholders may then have to be patient.
In the meantime, however, there is a silver lining. Even when buybacks have little impact on the investment trust’s share price, there’s something else useful going on. Investors who hold on to their shares are automatically getting an uplift in the intrinsic value of those holdings. With fewer shares in issue, each remaining share represents a larger stake in the fund’s assets – in other words, the investment trust’s net asset value per share increases.
The effect can be spectacular. Research published by Kepler Trust Intelligence last year found that more than 40 investment trusts running buyback programmes had raised net asset value per share by more than investors were paying in fees to the funds’ managers. In other words, in net asset value terms at least, investors were getting those funds for free.
To give an example, Kepler looked at Scottish Mortgage Investment Trust, which ran the industry’s biggest buyback programme last year. The analyst calculated the fund had delivered, in aggregate, around £180m of benefits for shareholders in terms of an uplift in net asset value per share. Those investors collectively paid around £39m in management fees at Scottish Mortgage last year. The buybacks therefore delivered benefits worth more than four times the charges that investors paid.
Now, there’s an important caveat here. If a fund’s discount doesn’t move – for whatever reason – that additional value can be difficult to unlock. The extra net asset value per share won’t all translate into share price gains, which investors can cash in by selling their shares.
Nevertheless, over time, the impact should be positive. When funds outperform in terms of asset value, the market takes note. And when the discount does start to close – perhaps as investors become less risk averse – shareholders can look forward to significant upside
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
