Why zero discount policies aren't all they're cracked up to be

Calls for zero discount policies to become widespread have grown louder in recent months, but they could prove be costly for investors.

Holding up the likes of Personal Assets and Finsbury Growth & Income as examples of how investment trusts can keep discounts at bay, those in favour of strict discount controls say they could help the closed-end sector compete in the post-retail distribution review (RDR) world.

But experts warn that in the wrong hands, zero discount policies can cost shareholders dear. During a bad patch trusts could be forced to sell investments just to keep up with their commitment.

Address volatility, not discounts

Alastair Smith and Grant Challis, of Frostrow Capital, believe boards eager to introduce zero discounts should tread cautiously because it is not the fact trusts trade at a discount that bothers investors, but volatility.

They argue by curbing volatility, even trusts trading at a discount would ensure moves in its share price mimicked closely the shift in portfolio net asset value (NAV), and this would have the knock-on effect of addressing angry investors' concerns.

'Volatile discounts are what people don't like.  It's very different to the NAV return, what the fund manager is actually delivering,' said Smith, Frostrow's managing partner.

Moreover, Challis pointed out there are probably only a handful of trusts using zero discount policies because it would not be practical to introduce them across the sector.

While some commentators believe removing discounts would help trusts attract business in the post-RDR world, Challis said funds that invest in illiquid assets would struggle to cope.

He explained: 'Private equity and infrastructure are assets held in a closed-end structure for a reason.'

In order to meet zero discount rules, Challis pointed out some investment trusts could be forced to sell investments to return money to investors when shares are bought back, a popular means of keeping share prices in line with NAV.