‘Share buybacks don’t work’: Does the data back up that claim?

Investment company share buybacks have surged by over 50% as closed-end funds have fallen to wide discounts to net asset value in this year's bear market. But do they work in narrowing the valuation gap?

Share buyback announcements have become an almost a weekly event within the investment company space as closed-end funds trade at low levels below net asset value not seen since the 2008 financial crisis. Nevertheless, several critics have emerged saying the lauded discount management tool does not do its job.

Investment trust discounts are at an average of 14% across all sectors, according to Morningstar figures, their widest point in 20 years, except for the great financial crisis when they hit 18%.  

In response boards have taken to buying back shares to help bridge the disparity between supply and demand, therefore narrowing the discount, with £2.2bn worth bought in the 8 months to August, a 53% increase from the equivalent period of 2022.

However, a report from Numis earlier this year said boards should set ‘realistic expectations’ as buybacks ‘are unlikely to march in a discount’. This view has been gaining credence and Baillie Gifford’s head of distribution James Budden took a similar stance at a recent forum, saying there was little evidence of the mechanism’s success.

Figures for Citywire from Morningstar and Winterflood back the claim that they are far from a silver bullet. The table below shows the 20 trusts that have bought back the highest percentage of their overall share capital this year. While 60% have a discount lower than their peer group, many of the other 40% have a discount substantially higher than the average.

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Investment company % of share capital Discount Sector Discount
Troy Income & Growth (TIGT ) 15.5% -1.3% UK Equity Income -3.8%
Mid Wynd International (MWY ) 14.8% -1.7% Global -12.3%
Biotech Growth (BIOG ) 10.8% -7.0% Biotechnology & Healthcare -13.0%
Worldwide Healthcare (WHH ) 9.8% -8.3% Biotechnology & Healthcare -13.0%
Capital Gearing (CGT ) 9.5% -1.9% Flexible Investment -22.3%
Third Point Investors (TPOU ) 9.3% -18.0% Hedge Funds -9.9%
Riverstone Energy (RSE ) 9.1% -52.9% Commodities & Natural Resources -12.4%
Rights & Issues (RIII ) 7.5% -15.9% UK Smaller Companies -12.9%
MIGO Opportunities (MIGO ) 7.4% -2.0% Flexible Investment -22.3%
Abrdn UK Smaller Companies Growth (AUSC ) 6.9% -13.4% UK Smaller Companies -12.9%
Temple Bar (TMPL) 6.7% -5.8% UK Equity Income -3.8%
Asia Dragon (DGN ) 6.5% -16.1% Asia Pacific -10.1%
STS Global Income & Growth (STS ) 6.1% -1.1% Global Equity Income -2.6%
Witan (WTAN ) 6.0% -7.5% Global -12.3%
Herald (HRI ) 5.8% -13.6% Global Smaller Companies -13.7%
JPMorgan Multi-Asset Growth & Income (JGGI ) 5.5% -2.9% Flexible Investment -22.3%
Jupiter Green (JGC ) 5.5% -15.3% Environmental -8.5%
Martin Currie Global Portfolio (MNP ) 5.3% -1.7% Global -12.3%
Murray Income (MUT ) 4.9% -8.1% UK Equity Income -3.8%
Smithson (SSON ) 4.9% -10.3% Global Smaller Companies -13.7%

Source: Morningstar, Winterflood Securities. Buyback data to 13 September, discount data as of 15 September.

The lack of success hasn’t deterred some boards as Guernsey investment company Third Point Investors (TPOU ), which has already bought 9.3% of its total share capital extended its buyback programme this month as its discount remains double its peer group.

However, on the other side board and investment managers at Henderson Smaller Companies (HSL ) has looked through their own data and came to the conclusion they don’t work and so in their half year report said they would continue to monitor the situation but won’t be undertaking any for the time being. 

Janus Henderson took on the trust in early 2000s and proceeded to buy back 4% of equity from November 2002 to 2011. ‘It had little to no impact,’ Neil Hermon, portfolio manager of the trust, told Citywire. ‘By a month most of the benefit was completely lost’.

Looking at the long-term discount data for the trust it shows volatility over the period with minor fluctuations quarter to quarter, apart from 2008 when the discount dives due to the financial crisis.

For Hermon, whose trust is on an almost 13% discount, not only is the tactic unsuccessful, itis detrimental as it can ‘shrink the size of the underlying vehicle to irrelevance’. The manager of the £688m trust explained that as consolidation within the fund management space continues there is increased pressure on investment companies to ensure they are of a sufficient size to make it onto their buy lists and a buy backing shares goes against that goal.

‘Only half the story’

There are numerous counter-arguments to this view on buybacks, but the one most prevalent is that it is about more than just bringing in the discount.

Winterflood, which supports buybacks as a form of shareholder remuneration, acknowledged they are unlikely to close a discount but said they offer ‘volatility reduction’.

The broker added buybacks sent an important ‘market signal’ as they showed a board had confidence in the underlying value of a trust’s assets and think the market’s pricing is wrong, which is particularly important for the boards and managers of private assets where there are serious concerns about how assets are valued.

They are far from alone in their support. Peter Walls, manager of the Unicorn Mastertrust , an open-ended fund that invests in investment trusts, said as an investor he wants to see buybacks and saying they don’t work is ‘only half the story’.

‘They don’t work in what? They don’t necessarily narrow a discount, but for me they really do work in enhancing my net asset value at the margin,’ he commented. That marginal uplift to NAV is very important to Walls who said it can, in some cases, cancel out a trust’s annual management charge.

Deal structure matters

Managers at AVI Global Trust (AGT ) are hoping for much more than a marginal increase from Pantheon International (PIN ) which made a ground-breaking promise to buy back £200m of its heavily discounted shares in the financial year to 31 May.

To some extent its plan to use a mammoth buyback plan to move the dial on its 43% discount has already borne fruit, as it has narrowed 17% since the announcement on 3 August. However, Alex Denny, managing director at Pantheon was hesitant to put out the bunting saying ‘time will tell how persistent that is’.

For Denny the implementation of a buyback is as important as the task itself and boards have ‘a lot of difficult decisions to make’. He said ‘behind the scenes’ boards are deciding how they are going to do it and not all options will deliver a long-term shift in the discount.

There are two popular options for buybacks - a tender offer or a long-term buy back plan.

PIN is going for a somewhat hybrid approach between the two styles as in September, and after Denny’s comments, the board of the trust announced a £150m tender offer to speed up the process. Under a reverse auction, shareholders will be able to tender, or offer to sell back, their shares at prices of 2.5p increments between 280p and 315p. The company will set a strike price as the lowest it needs to pay to buy back all the shares on offer.

Denny said the benefit of a long-term plan of persistently buying back shares is the trust has a greater profit from each of the transactions. ‘If you buy back shares at a 40% discount, you’ve got basically 40% upside straightaway and that is returned to all of the remaining shareholders’. Under this mechanism the buyback scheme is ‘more favourable’ to investment shareholders than the ones who are leaving.

Under a tender offer there is a ‘pull to promissory price’ but the purchase of the shares would also ‘clear a whole load of people off your register’ and nothing would prevent the discount moving back out again. He added these offers may also see wealth managers and other institutional investors sell even though they hadn’t planned to since they have a duty to their customers to get the best possible deal.

Tom Treanor, head of research at Asset Value Investors, manager of AGT, believes Pantheon’s approach, which he sees as an investment decision rather than solely a discount control mechanism, should help lift the trust’s NAV by a minimum of 7%. He calculated the £200m buyback could generate a total return on investment of 88%

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