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If you cast your mind back to July – which I know seems aeons ago – you might just remember Spotlight looking at the historically wide discount levels among investment companies, which are comparable to those of the financial crisis.
So what happens next? Of course we have no idea: but we did think it would be interesting to look at what has happened in the past when discounts have been at these levels.
We looked at three discount “troughs”, based on month-end figures: March 2003 (-12.8%), February 2009 (-16.4%) and June 2016 (-11.9%).
The annualised returns of the average investment company in the three years following each trough were 34%, 22% and 9% respectively. Clearly, some of the difference is explained by the fact that the first two troughs occurred towards the end of major bear markets, while the third came after the ‘leave’ vote in the EU referendum, which was hugely significant for the UK but less so for global markets.
Looking at which sectors performed best in these recoveries, it is all about growth. Smaller companies is a common theme, and especially UK smaller companies which outperformed the average investment company in all three periods. Global emerging markets and private equity also did well. For all these sectors, narrowing discounts provided an extra boost to returns.
Both commodities and financials delivered more mixed results, reflecting the different macro factors at play in each of the recoveries.
None of this is to say that we are in the trough quite yet, though Elliott Hardy at Winterflood believes that current discount levels represent an attractive opportunity for long-term investors, “who may benefit from the double-whammy of improving NAV performance and tightening discounts when investor sentiment improves.” He adds that interest rate sensitive assets, such as infrastructure, property and private equity, may be particular beneficiaries once rates peak.
Investment companies do have one weapon in their arsenal to fight back against gaping discounts. According to Winterflood analysis of Morningstar data, buybacks totalled £2.7 billion in 2022, a record high, and have reached £2.5 billion in 2023 to date.
One high-profile example over the summer was Pantheon International, which announced that it had ringfenced £200 million for buybacks (chairman John Singer explains why in this short video).
While not a panacea, buybacks are a powerful tool especially for larger investment companies, which can use them to mop up excess supply of their shares, grow their NAV per share and hopefully shrink their discounts. For those investment companies that invest in alternatives, they also indicate confidence in the valuation of their portfolios and provide a positive signal to investors.
Cost disclosures
Another issue that has been much talked about over the summer is cost disclosures. It’s a complex, multi-faceted issue, and the AIC has been engaged with various aspects of it for several years, not least to try and level the playing field between investment companies and open-ended funds.
While consumer disclosures (KIDs versus KIIDs) continue to sow confusion, the bundling of investment company costs into the charges of funds that invest in them has also had unintended consequences.
We have been leading work with the FCA and policymakers to get early action on the specific question of aggregating underlying fund costs. We’re also continuing to push for an acceleration of the work on an overall cost disclosure framework, arguing for a layered approach that does not disadvantage investment companies, is transparent and (most importantly) might actually be helpful to an investor.
To end on a happier note, the AIC team will be heading once again to the Novotel London West on 20 October for our second Investment Company Showcase. More details below – I hope to see some of you there.
Upcoming events
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