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Nick Sketch: do the pros outweigh the cons of discount controls?

by Nick Sketch on Apr 25, 2014 at 14:32

At first sight, discount controls look good for the NAV and the discount (so a double-win for the share price), but bad for liquidity. After all, who would sell shares cheap when they can sell to the manager on known terms every month?

Cleaning out weak holders at non-distressed prices won’t itself help liquidity for buyers, though it will help other sellers.

However, a credible discount control mechanism and a credible investment case in combination can produce a virtuous circle. The shares trade at around NAV, so the company can meet demand by issuing new shares or can buy back and cancel if needed, and is essentially behaving rather like a unit trust, but with the benefits of real-time pricing. Thus, if there really is high demand for the shares, then they will either trade at a big premium or there will be consistent issuance of new stock – which can only be good for liquidity.

Witan has bought back nearly half its shares in the last decade or so, but genuinely strong performance and a coherent approach means it now trades at a tiny discount. If demand continues, Witan , led by CEO Andrew Bell, could be issuing stock before too long, and the strong getting stronger should not surprise anyone.

Of course, an increased focus on discount controls may be just one more factor making niche trusts into an endangered species. It may also discourage innovation on capital structures or a focus on less liquid assets. To put it another way, it is usually right when fielding any investment question to answer that the issue is a lot more complex than it appears, and that is certainly true for discount control mechanisms.

Nick Sketch is a senior investment director at Investec Wealth & Investment 

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