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Can narrow gauge put trusts back on track?

The AITC is changing the way it calculates net asset values in a move which will narrow the discounts of dozens of investment trusts. From the end of June, NAVs will take into account debt at fair value, essentially meaning that NAVs will be based on current market price rather than the final repayment value.

Analysts say the effect will be twofold. First, the NAVs of trusts with high debt will see their – often wide – discounts narrow to a more realistic level as the impact of servicing the debt is factored in. For example, a trust trading on an 18 per cent discount to NAV would see its discount narrow to, say, 14 per cent with debt included.

Most professional investors and analysts automatically make this calculation but trusts and data providers usually do not, meaning that many IFAs and investors buy on the basis of a wide headline discount.

AITC spokeswoman Jemma Jackson says: “We think many people think the discounts are wider than they actually are. This is not a huge problem necessarily but non-professional investors are not in a position to factor in the fair value of debt. This will make it easier.”

The second impact will be the leveling of the playing field between trusts with different levels of debt. The average investor will be able to make meaningful comparisons as discounts between trusts better reflect their true value.

Broker Close Wins analyst Simon Elliott says: “The real benefit is being able to compare like with like. So a trust like Scottish Mortgage, which trades on a wide discount because it has high levels of debt, can be compared fairly with, say, F&C, which has less debt and a smaller discount. At the moment they look different but they are actually quite similar.”

The AITC, which is recommending that the new method of calculation is adopted by data providers as well as non-members, says the move should affect around 40 trusts. These will usually have taken out or issued long-term debt with higher interest rate payments than currently on offer in the market.

The average trust will see its discount narrow by between 1 to 1.5 per cent but the AITC believes some discounts will be slashed by 4 per cent or more. Given that the average AITC member trust currently trades on a discount of 12.7 per cent, this could cut discounts on a relative basis by a sizable amount.

There is little doubt that some trusts will benefit but are there wider implications? Iimia head of investment trusts Nick Greenwood says: “What it will do is stop advisers just looking at the raw figures so we will see fewer misinformed investment decisions based on the wrong data. It makes it more user-friendly because it is something of an anomaly at the moment.”

Arbuthnot Securities analyst Tom Tuite-Dalton says the change will prevent investors getting burnt by well-meaning but inaccurate recommendations. He says: “Showing the lowest possible NAV makes sense. In the past, investors have not been aware of the difference and have bought trusts they thought are cheap but which actually came with a slight handicap. It is a positive move for the sector.”

But will it have an impact on sales? Experts believe it is unlikely that IFAs will be persuaded that closed-end investments are worth their while.

Whitechurch Securities investment director Gavin Haynes says: “There should be some opportunities but investment trusts are still on the periphery for most generalist IFAs. It will just increase transparency for those advisers who already use them.”

The trouble as far as most advisers are concerned, says Haynes, is that they have to take a position on the attractiveness of the sector in which a trust sits as well as on the assets themselves. As closed-end investments, investment trusts are at the mercy of supply and demand so, if a sector falls out of favour or underperforms, discounts are likely to widen at the same time that NAVs are falling. But Haynes believes this is the time to start trawling for bargains. As soon as a sector falls from grace, he and his team look for trusts likely to benefit from narrowing discounts and rising NAVs.

But advisers tend to want stability. Most boards recognise this but few have made strides to restrain oscillating discounts. Finsbury growth is an exception, having implemented a control mechanism whereby the board&#39s broker must defend a 5 per cent discount. If an investor selling shares cannot find a buyer at a 5 per cent discount or below, the board&#39s broker must sell the investor&#39s holding back to the trust. Not only has this improved shareholder value but it eradicates discount volatility.

Although the AITC&#39s decision will not harness volatility, it will make IFAs&#39 lives easier by giving them more accurate and helpful information. Boards will have to decide whether they are prepared to use the change to NAVs as a platform from which they can combat the discount volatility which so hampers their sector.

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