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In the first 10 months of 2025, investment trusts bought back more than £8.6bn worth of shares — 35 per cent more than in the same period last year. The aim was to close the discount between the share price of the trust and the value of the assets it contains per share. Did it work? Not very well; discounts remain stubbornly high for many trusts.
To explain why, we need to understand why there are discounts in the first place. This is a question I get asked a lot.
The big difference between an investment trust and a unit trust or “fund” comes when you want your money back. In an investment fund when lots of holders decide to sell units, the manager must dispose of underlying assets — and quickly. Fine if they’re liquid. Not so easy if those assets are something like property or a wind farm.
In a closed-ended investment trust, if you want your money back the manager doesn’t have to sell. The onus is on you to find a buyer for your shares. When the shares are less popular, buyers may offer less than the value of the underlying assets — a discounted price.
A discount, then, is the price you pay for liquidity, but it’s also an incentive for being patient. And that makes investment trusts an excellent vehicle for buying less liquid assets, like smaller companies, which can earn an illiquidity premium. This illiquidity reward is why over 25 years, for example, the smaller company equity index has outperformed the main market.
The discounts available today on income-generating assets can boost future returns significantly, too. If you buy £1 of assets for 90p you have the full £1 working to generate dividends, and that should compound over time. The closed-ended structure also allows gearing to be safely deployed, which can apply even more turbo to returns over time.
Today’s discounts — typically 14 per cent — are higher than average. We might expect them to close more than widen over the long term. But how? This year’s extraordinary level of share buybacks and windups has had little impact.
For a discount to close there needs to be a belief that the trust isn’t just a collection of assets. There needs to be a secret sauce — human expertise in managing the assets to enhance their value over time.
This has always been the case in the quoted property sector. A portfolio of properties will normally trade at a discount unless the managers can squeeze more out of the assets either by smart trading or by revitalising them.
The same was the case when the investment trust sector was used to inject capital into Lloyd’s of London. In 1992, the historic insurance market was on its knees and virtually bust. It needed a new supply of capital, which came with its plan of reconstruction and renewal.
Investment trusts were launched that pledged some of their capital to sit behind certain underwriting syndicates. The effect in the good insurance years was to boost the earnings of the investment trust, but a short-term earnings boost isn’t proof of a long-term earnings flow. The trusts went to discounts. The source of real value was the underwriting skills in some of the syndicates. And the trusts didn’t own that.
The answer in time was for the trusts — simply the providers of capital — to be folded into the managing agents that did the underwriting. Today, Lloyd’s insurer Hiscox trades at around 1.8 times its asset value, and many of the others that were originally investment trusts have been taken over at large multiples of book value. That experience is why I say it’s management skill that brings in discounts.
An area where there are currently large discounts is infrastructure and renewables. Too many managers have done little but buy assets. The dividends they generated when rates were low looked great, and the sector shot to a big premium. Rising rates have scuppered that. Those premiums are now deep discounts.
Many believe the answer is mergers and buybacks. But what is needed, in my view, is more proactive asset management. In fact, buybacks arguably only make the teams that want to be active despondent, because they have to be funded through disposals of the assets they would like to sweat.
What does this mean for the investor saving for the long term? Don’t get too hung up on discounts — they can work to your favour. Focus on the trusts that play to the structure’s strengths — that make the most of the illiquidity premium and of gearing, that give you access to assets you can’t buy easily, and where you can see the managers’ skill adding long-term value.
James Henderson is co-manager of the Lowland and Law Debenture investment trusts