With investment trust share prices trading at close to the highest discounts to NAV ever seen, this year has witnessed a busy year for share buybacks in the industry.
A day after the investment trust industry saw the average discount widen to almost 17% - the most since the global financial crisis in 2008 - research from Peel Hunt found more than £3 billion worth of shares have been bought back by London's closed-ended investment companies, of which £2.6 billion was by equity funds and the minority by alternative asset funds.
While the true effectiveness of buybacks continues to be debated, the research found that equity-holding trusts that bought back at least 5% of their issued share capital saw a less severe widening of discounts than their peers.
This difference was an average of two percentage points for equity trusts pursuing buybacks versus peers that were not.
"Indeed, within this subset, we note a meaningful (c50%) correlation between the proportion of shares bought back and how well the relative rating has held up YTD," wrote Peel Hunt analyst Thomas Pocock.
An unusual new feature was the prevalence of buybacks in alternative asset funds and their effectiveness, with a four percentage point narrower discount for newly implemented buyback programmes at infrastructure funds compared to peers that have not bought back shares.
Most buybacks are from trusts with discount control mechanism (DCM) targets, including Troy Income & Growth at £30 million or 16% of its total shares in issue and Capital Gearing Trust PLC (LSE:CGT) at £141 million or 12% of its total, as both have zero-discount policies.
Nine trusts have bought back more than £100 million of their own shares in the year so far, led by Worldwide Healthcare Trust PLC (LSE:WWH) at £206 million, RIT Capital Partners (LSE:RCP) at £156 million and Capital Gearing.
Why are discounts so big?
Also this week, analysts at AJ Bell looked at what is driving the discounts and the use of 'Z scores' that allow investors to measure how far away from the norm each discount is.
They noted that the long-running antipathy towards UK shares is now powerful force that goes some way to explaining weak investor demand, with a whopping £44 billion withdrawn from open-ended UK stock market funds since 2016.
Another, they argue, is the continued rise of passive investing, which have grown from from 9% of total open-ended assets 10 years ago to 22% today.
"Being active vehicles, investment trusts aren’t immune to this structural trend," said AJB analyst Laith Khalaf.
What Z-scores can tell us about current discounts
Examining the intersection of widening investment trust discounts and Z-scores unveils where historical trends, investor sentiment, and macroeconomic shifts collide, says Khalaf, and can provide a fertile ground for discerning investors to assess value in a turbulent market.
First, he cautions that investment trust discounts need to be read against the market and its own historical context - "as a trust trading at a discount might actually be priced closer to NAV than it has been historically, and so might not represent good value".
A Z-score (when related to a discount) shows the number of standard deviations by which a discount is above or below the mean value - typically over the past year. Scores above the mean (ie narrower discounts than history) have positive scores, while those below the mean (wider discount) have negative scores.
Using Z-scores provides an indication of how far a trust’s discount (or premium) is trading below (or above) its historical average.
With a negative Z-score indicating the current discount (or premium) is below average levels and a positive score tells us it’s above average levels, a Z-score of between 0 and -1 broadly suggests a trust is cheap by historical standards, but not hugely so.
Meanwhile, a score of between -1 and -2 suggests a trust is significantly cheaper than usual, and a score below -2 suggests a trust is trading near the very bottom of its previously observed range.
Discounts and Z-scores in selected AIC sectors
Average Discount · Z-score 5-year
Private Equity · -34.0 · -0.8
Infrastructure · -32.2 · -2.0
Renewable Energy Infrastructure · -30.2 · -2.8
Property - UK Commercial · -29.6 · -1.1
Flexible Investment · -21.7 · -1.3
North America · -19.1 · -1.1
Global Smaller Companies · -17.8 · -1.2
UK Smaller Companies · -15.2 · -0.2
UK All Companies · -13.6 · -1.0
Asia Pacific · -11.7 · -1.7
Europe · -10.8 · -0.5
Global · -10.6 · -1.1
Japan · -7.6 · 0.0
Global Equity Income · -6.6 · -1.3
UK Equity Income · -6.2 · -0.8
Global Emerging Markets · -0.5 · -1.0
Looking at the last five years of pricing data, Khalaf found that the average trusts in almost all sectors are trading at discounts below their longer term average, with many averages suggesting it would be a "decent entry point" for these sectors, he said, "and when you come to sell, chances are you will do so closer to the net asset value of the trust".
However, he cautioned that interpreting Z-scores is made more difficult given the sharp change in the interest rate environment, which has gone from near zero at the end of 2021 to over 5%.
Some sectors are especially sensitive to interest rates, such as property and infrastructure, and the average trust in both the renewable energy infrastructure and general infrastructure sectors is trading at a five-year Z-score of below -2 - though Khalaf notes that this partly reflects the high premium put on income streams from this sector when interest rates were near zero.
"Today’s very pronounced discounts are clearly at the other end of the spectrum, and the contrast here explains the extreme level of Z-scores currently at play in these sectors.
"Looking at the Z-score over a shorter time frame which excludes the period of ultra-low interest rates would yield more moderate results, but would also incorporate less market data."
The analysts also adds that, of course, when picking trusts investors need to inspect the statistics for individual funds as there can be a wide range of variation within different trusts in the same sector.