Invesco Asia Trust (IAT) has been forced to undertake a tender offer to buy back up to 15% of its shares in a bid to narrow the chronic discount on its stocks, despite a period of decent performance. What's going on?
The trust’s discount control policy is implemented if its shares on average trade more than 10% below their net asset value (NAV), when income is stripped out, over a 12-month period. As the shares traded at an average discount of 10.9% over the year to the end of April, the board has decided to trigger the tender at a 2% discount to NAV, minus the costs of the transaction. This is much narrower than its current discount of 10.4%.
The tender offer is open only to existing shareholders and is due to take place at the end of the 2017 financial year, if it is approved at the annual general meeting in August. As investors are being given the opportunity to sell their shares at a lower discount, Numis expects the tender offer will be over-subscribed.
The board also bought back just over 2 million shares during the year to May. Share buy backs form another component of Invesco Asia’s discount control policy, which has been in place since 2010.
The trust's current discount is wider than the average of 7.4% in the Association of Investment Companies’ (AIC) Asia Pacific excluding Japan sector.
Invesco Asia's discount could be considered high, given that the trust has had a stellar year. Under manager Ian Hargreaves, its share price has risen by an impressive 47.9%, ahead of a 41% gain by the average trust in the sector. This ranks it fifth out of 15 trusts in the Assocation of Investment Companies' Asia Pacific sectpr. The underlying performance of the portfolio has also been strong with NAV growth of 47.5%.
Hargreaves took full control of the portfolio at the start of 2015 but was a co-manager with Stuart Parks, head of Asian equities at Invesco Perpetual, for the previous three years.
Its relative performance over five years is slighly less impressive, however, with a 100% total shareholder return ranking it in seventh place although much higher than the 76% sector average return,
As many of the trusts in Asia Pacific excluding Japan currently trades on a discount, Alistair Hodgson, an investment manager at stock brokers Pilling & Co, suggested investors could be overlooking the sector, in favour of Asian income and broader international equity funds.
'I would expect the discounts to narrow if there is a strong run for Asian markets and the sector gains wider recognition,' he explained.
A new approach to discount control
In light of the proposed tender offer, the board is considering whether it should take a different approach to controlling the trust’s discount in the future ‘to ensure that the company remains attractive to the broadest possible range of long-term investors’.
This comment alludes to the fact that Invesco Asia is potentially constrained by its shareholder base. Top shareholders include City of London Investment Group (CLIG) and Wells Capital, both well-known value investors, who like to buy trusts on steep discounts and wait for them to narrow. They are likely to participate in the tender.
If they do and the tender is fully subscribed, the discount is likely to narrow. However, Cantor Fitzgerald investment companies analyst Markus Jaffe says this may only prove to be a short-term measure because shareholders may then sell once the discount has narrowed. At this point, it is crucial that there is fresh demand for the trust’s shares – otherwise the discount will widen once again. The trust’s value-focused shareholder base could therefore put potential investors off.
‘If you are an investor is looking to buy one of these trusts, you will think which one has potential discount upside. You then look at the register and say, “these guys will be sellers when the discount gets to 5% or 6% or even a few percentage points narrower”, so you are not going to buy in,’ Jaffe said.
‘Once the discount tightens, there needs to be some buying at the new level and for people to believe it is an attractive purchase,’ Jaffe explained.
So, what other discount control mechanisms are available?
They include regular buybacks, tender offers and continuation votes. The latter allows shareholders to vote on whether the company should continue to exist. Zero discount policies represent another option and involve the board either issuing shares at a small premium whenever demand for shares exceeds supply. Alternatively, the board buys back shares at a small discount, effectively mopping up excess shares when investors are selling in order to stop the discount widening. These measures keep the share price in line with the NAV.
Other routes include an annual redemption facility, which allows shareholders to redeem all or part of their holding each year, alongside enhanced dividend policies. By increasing dividend payouts, it can make a trust more attractive in the eyes of income-seeking investors.
‘Boards have typically favoured mechanisms that offer them some flexibility and therefore have preferred not to state a specific target discount level. Only circa 20% of the investment companies universe have some form of precise discount target,’ explained Anthony Leatham, head of investment trust research at Peel Hunt.
Trusts with policies that are tied to specific discount levels, like Invesco Asia, can run into difficulties because the prescriptive rule fails to take into account the range of factors that can cause discounts. These include the market environment, volatility, liquidity in the trust and sentiment.
‘In addition, a specific target can open the door for “discounted assets” investors to take advantage of this commitment and, in the case of Invesco Asia Trust, this type of investor makes up around 40% of the current shareholder register,’ Leatham added.
So, how can trusts break the cycle of a persistent discount? With difficulty, according to Hodgson.
‘There is no magic formula for these things because a discount control policy that is too weak allows discounts to get too wide, hiding the NAV performance. Too strong and the trust eats itself up if there is a long period of lacklustre performance or the trust shares struggle to find buyers,’ he noted.
One of the biggest advantages of closed-ended funds is that the fund manager can focus on managing the portfolio, without worrying about flows in and out of the fund. Open-ended funds, on the other hand, can see their investment approach affected by redemptions.
In order for closed-ended funds to prosper, Hodgson suggested that in some cases investors must have patience and not pressure boards too much to buy back shares.
'In short, there is a balance to be achieved between long termism and short termism,’ he added.
If there is a prolonged lack of demand for shares, Hodgson said a last resort could be to consider whether changing the investment approach might improve appetite for the stock.
Jaffe suggested that Invesco Asia’s team could benefit from organising a round of meetings with potential investors in order to raise their profile and draw attention to the trust’s strong performance track record.
Size is another consideration. If the tender is fully subscribed, Peel Hunt estimates that at today’s NAV, Invesco Asia will reduce in size to £200 million in net assets. While Leatham says this is still viable, it is important that it doesn't get much smaller.
'There is clearly an underlying concern that trusts below a certain size can risk irrelevance in a world of consolidating wealth managers – an issue facing around 20% of the Asia ex-Japan trust sector.
'In contrast, any improvement in the breadth of the shareholder register as a result of the tender offer should improve liquidity in the trust,' he said.