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LIQUIDITY
Investment Trusts sell their own
shares on the market, so they don’t
have to pay as much attention to their
investors’ activity as their open-ended
counterparts - the liquidity is based
upon the demand for the fund’s own
shares. Open-ended funds have to have
more liquidity within their fund in order
to meet any requests for redemptions.
If they don’t, in a falling market they
may be forced to sell some of their
underlying positions in order to meet
liquidity flows. In an Investment Trust,
these flows can be absorbed by the
discount (i.e. - the discount widens or
narrows according to the supply and
demand dynamic).
What does this mean in practice? It
means Investment Trusts can afford
to make investments in more illiquid
assets - such as unquoted companies
in the case of VCTs (or property or
infrastructure in the wider closed-
ended fund universe for example).
We should also note here that very
often Investment Trusts will also buy
their own shares back off investors,
offering an additional exit route.
Investors do not have to rely solely
upon the secondary market, and in
fact buybacks are probably the most
common way to exit.
NAV VS. SHARE PRICE
A corollary to this is that an Investment
Trust’s share price is a reflection of
the supply and demand for its shares,
and not necessarily a reflection of the
value of its underlying portfolio of
investments.
Very often, demand for shares in the
trust on the secondary market can be
low because investors prefer to make
purchases of new issues to obtain the
Income Tax relief. Therefore the shares
tend to trade at a discount to the Net
Asset Value (NAV) of the fund. This can
be a frustration for current investors
who want to exit - the price they achieve
will not reflect the true exposure to the
underlying assets. This is where the
buybacks mentioned above become
so important. Most Investment Trusts
will undertake to buy shares back at
an agreed level of discount - often 5% -
giving investors some protection if the
discount is any deeper than that.
Trading at a discount can also be
interpreted as an opportunity for
buyers in the secondary market. And
of course it can work the other way
around: if demand for shares in the
trust is high, then the shares will trade
at a premium to the NAV.
SMOOTHING DIVIDENDS
Another benefit is that Investment
Trusts can retain income. This means
that dividends can be smoothed over
time and continue to be paid out, or
even increased, in a falling market.
This a great benefit for investors who
are looking for income and another
advantage over OEICs.
CORPORATE GOVERNANCE
Another feature of Investment Trusts is
their corporate governance structure.
This is an important positive point for
VCTs. Investors are also shareholders
in the trusts (not just customers) and
their interests are represented by an
independent board of directors. The
board has the power to appoint the
investment management company
who will manage the assets within the
trust, and will monitor their ongoing
performance. If they feel that the
manager is underperforming, they can
be sacked and replaced.
The board also examines the charging
and fee structure and incentives for
the manager. This structure provides
a unique layer of governance that has
responsibility to act in shareholders’
interest at all times, a feature that is
lacking in OEICS and (S)EIS.
Unsurprisingly, these additional rules
mean that there are some additional
considerations: in particular how the
non-qualifying 30% of the portfolio is
ADDITIONAL RULES FOR VCTs
There are some additional rules for
VCTs to ensure they are meeting
the objective of funnelling capital to
smaller companies (and representing
value for money for UK taxpayers).
At least 70% of their investments
must be in qualifying investments –
small companies (maximum size £15
million) that are unquoted or traded
on the AIM rather than the main stock
market
They must invest in the companies
within three years of raising new
money. Keep in mind that they may
invest elsewhere while making these
decisions, so the risks can be different
They can’t invest more than 15%
of their total investments in any one
company
They can’t retain more than 15% of
the income from the underlying asset
managed (although the rules on this
were tightened in 2015) and how new
money will be managed before it is
deployed (potentially three years after
the investment), so advisers need to
look beyond the headline activity of
the VCT. There’s more on due diligence
on page 49. The three year rule also
means that the managers have to
think carefully about their fundraising
- raising more than they can deploy
within the timeframe could put them
under undue pressure.
Compliance with the additional rules
is vitally important, complicated and
labour intensive. This is one of the
reasons why VCTs cost more than
mainstream funds.
“Liquidity for VCTs is based on the demand for their shares on the market, so they can afford to invest
in more illiquid assets compared to open-ended funds. However, advisers need to be cognisant of how
liquidity is provided, looking at the risks hidden under the bonnet”
Mark Wignall, Mobeus Equity Partners