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Discussing discounts

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1 August 2019

David Prosser discusses the narrowing of discounts in the investment company industry.

Sometimes, your greatest strength can also be your biggest weakness. So it is with investment companies. On the one hand, their closed-ended structure protects investors from the kind of problems seen at open-ended funds such as Woodford Equity Income in recent months, with managers forced to sell assets to meet redemption requests. On the other, this means shares in an investment company trade at a discount or premium to the value of the underlying assets – for many years, this complexity has been a consistent complaint of advisers and investors steering clear of the closed-ended fund sector.

In this context, work published by Edison Group investment analyst Sarah Godfrey over the past week makes interesting reading. The average investment company (excluding VCTs) was trading at a discount of just 1.44 per cent at the beginning of May, she points out, within touching distance of the all-time low of 0.59 per cent. The average has since widened to around 3 per cent, but discounts remain, in aggregate terms at least, pretty negligible.

In fact, this is a long-term story. There was a time when most investment companies routinely traded at double-digit discounts. But that hasn’t been the case for a decade or so – and over the past five years, average discounts have generally been below 5 per cent, other than a brief spike around the time of the EU referendum.

Moreover, while the average does mask some very notable outliers – insurance-focused funds currently trade on an average discount of around 45 per cent while renewable energy infrastructure funds are on an average premium of about 15 per cent – low discounts are a feature of many more sectors than you might imagine.

Certainly, the income-focused funds have led the way, as investors frustrated by the poor returns on cash savings have looked elsewhere for yield. Both debt-focused sectors and those offering income from equity exposure are on discounts below the overall average.

However, there are plenty of non-specialist income sectors available at close to par too. In the equity sphere, Global, Japan Smaller Companies, Environmental, and Biotechnology & Healthcare are all on lower-than-average discounts.

In other words, there is no single explanation for the way in which investment company discounts have come down in recent years. The demand for income has boosted demand for many investment companies, helping their discounts. But other factors include the strong performance of many closed-ended vehicles and a willingness by investment company boards (sometimes prompted by activist investors) to actively manage their discounts.

None of which is to say, by the way, that discounts are necessarily a bad thing – they can offer value. It was interesting to note one national newspaper this week tipping the shares of Polar Capital Technology Trust and Allianz Technology Trust, both trading at a discount, as a cut-price route into tech stocks that many analysts fear are currently over-priced.

Still, there’s no doubt that discounts (and to a lesser extent premiums) have put some advisers and investors off investment companies over the years. It is therefore good news that we are now seeing a much narrower range of discount movement.

In fact, there’s a virtuous circle to be had here. With narrower discounts and less volatility, it should be possible to encourage more investors into the sector, boosting demand across the board. And that will offer further assistance with keeping discounts at a reassuring level.

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