The ability to buy a basket of assets for less than their true value should be one of the great advantages of the closed-end structure.
Admittedly, that opportunity has dwindled of late. Research from Numis reveals the average discount on an equity investment trust is now around 5%, the tightest level since 2008.
Historically, such narrow pricing has tended to be followed by a derating and a proliferation of double-digit discounts.
But should that occur in the weeks and months ahead – and it may very well not, given the increased adoption of discount control mechanisms – many wealth managers will find it difficult to snap up cheap portfolios because they are restricted by buy lists.
Charles Cade, head of investment companies research at Numis Securities, notes the types of trusts most attractive on a valuation basis also tend to be those that are least appropriate for a buy list – essentially those that are fairly volatile and/or illiquid.
‘Those sorts of funds really can’t feature on a buy list,’ Cade said. ‘You need to be able to invest in size, while buy lists also have to last for six months or more.’
Oliver Tucker, a fund of funds manager at Sarasin & Partners, regrets that this should be the case.
‘If you put the client’s interests first, issues like being able to buy in scale and keeping a fund on the buy list should be the least of your priorities,’ he argued.
Tucker (pictured) accepts that buy lists have a crucial role to play for wealth managers, but contends that they should retain some flexibility.
‘The buy list syndrome turns investment into a science, when it should be an art. Ultimately, blanket approaches lead to peculiar things happening,’ he said. ‘The key to whether a buy list is any good is how well it is managed.’
And are they generally managed well? Tucker fears they are not, and cites the UK equity income sector as a case in point. Closed-end funds in this space hold £9.1 billion of assets, dwarfed by the £69.1 billion in their open-ended rivals.
The latter have returned an average of 13.4% over the past year, and the former 19.8%. Among those investment trusts, stars such as AAA-rated Mark Barnett’s Edinburgh trust can be bought on a 2.5% discount, the victim of a Woodford-induced derating.
Looking at the gulf in assets between the open and closed-end products, Tucker asked: ‘Does that mean investment trusts are not getting the penetration they should? I think you would have to say yes.’
So what else are those constrained by buy lists missing out on at the moment?
Cade suggests that emerging market trusts are one area where wealth managers could profit from switching out of open-ended vehicles and into their closed-end equivalents to exploit the sell-off. Aberdeen New Dawn is available on a 10.3% discount, for example, compared with a 12-month average of 8.3%.
‘It used to be a relatively easy way to make some money for clients, but that’s not the case any more,’ said Cade.
An alternative buy list model that could grant the licence to exploit such opportunities would focus on managers rather than their specific vehicles.
‘If buy lists were put together in the right way, the open-ended funds that are contrarian choices would also be available as the investment trusts that operate in the same way,’ said Tucker. ‘I guess the shame is when buy lists are constructed according to what has done well in the past.’
What have the opportunistic been buying?
The activist City of London Investment Management has snapped up another 100,000 shares – worth almost £600,000 – in the Baring Emerging Europe trust, after its discount widened from 6.7% to 10.5% through March amid the turmoil in Ukraine.
The BNP Paribas Arbitrage team has been busily building a stake in Acencia Debt Strategies, which faces a wind-up vote before the end of the year and trades on a 6.5% discount. BNP Paribas most recently bought another slug worth almost £700,000.