Last week Scottish Mortgage Investment Trust announced a £1bn share buyback programme – the biggest ever in the investment trust sector.
At over £14bn, Scottish Mortgage is the largest investment trust in the UK and has historically been popular with investors. However, towards the end of 2021 and the first half of 2022 the trust fell significantly in value as global stock markets plummeted.
Some investors lost confidence, and the trust’s share price fell below what the investments held in it were worth. This is referred to as trading at a discount.
Scottish Mortgage isn’t alone though, with lots of other investment trusts trading on large discounts.
This article isn’t advice. Investments can rise and fall in value, so you could get back less than you invest. If you’re not sure if an investment’s right for you, ask for financial advice.
What can investment trusts do to close discounts?
Most investment trusts have a contingency plan to deal with trading at a discount, known as the ‘discount control mechanism’.
This gives the board, which makes sure a trust is run in shareholders’ interests, the discretion to direct the trust to buy back its own shares if they trade at more than a specified discount for a certain period of time.
The shares are then either cancelled, or held by the trust to be reissued at a future date. This mechanism is designed to reduce the discount and support the share price. It’s one reason so many investors like investment trusts.
However, not many boards have used it.
Why haven’t boards used the discount control mechanism?
There are lots of reasons why a board won’t buy back its own shares.
One of the main reasons is they often say they see better ways to use any spare cash they have. The problem with this is that it doesn’t inspire confidence in the managers of the trust. If the managers see better investment opportunities elsewhere, why should investors continue to have confidence in their portfolio?
However, if they use cash to buy back their own shares, it sends a signal they believe in the investments they hold. So, it’s disappointing that so many investment trust boards haven’t taken the opportunity to buy back shares when their trusts started to trade on large discounts.
What could the Scottish Mortgage buyback mean for investors?
Scottish Mortgage has made £1bn available to buy back its own shares over the next two years.
At the current price, this represents slightly less than 10% of the shares of the investment trust.
The hope is that buying back shares will increase their price and cause the discount to narrow and eventually close. This would mean the price of the investment trust is the same as the underlying value of the assets which it holds.
It’s too early to assess the success of the strategy, but early signs are good. Scottish Mortgage shares bounced over 5% immediately after the announcement was made. Though as always past performance isn’t a guide to future returns, and this doesn’t mean the share price won’t fall in future.
The strategy won’t be suitable for all investment trusts. But we hope the announcement will be a talking point in at least a few investment trust board meetings over the coming months, and that some might even follow suit.
Importantly, this isn’t the only strategy that will impact a trust’s share price or discount. Picking successful investments will be one of the biggest influences on performance, and an active discount control mechanism doesn’t mean that a trust’s share price won’t fall in future.
Investment trusts can sometimes invest in specialist areas like smaller companies, derivatives, and unlisted (private) companies which add risk. Investors should only invest in them if they have the time and knowledge to carefully select and monitor them. They should always be held as part of a diversified portfolio.
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