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Ian Cowie: Winterflood opens gate to debate about tenders

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Ian Cowie: Winterflood opens gate to debate about tenders

Are individual shareholders in investment trusts being disadvantaged in favour of institutional investors by an increasingly popular corporate manoeuvre? Could this move to narrow the discounts to net asset value (NAV), at which most investment trusts trade, also force managers to sell when prices are temporarily depressed?

Lest all that sound a bit technical, before your eyes glaze over I had better say that Templeton Emerging Markets (TEM) - by far the biggest fund in its sector with assets of nearly £2.2 billion - has just decided to adopt this controversial ploy. You can tell it really is controversial because even TEM’s house broker has voiced ‘misgivings’ about the move.

It’s also of importance to shareholders in at least seven other trusts - including Aberdeen Frontier Markets (AFMC); Baring Emerging Europe (BEE); BlackRock Latin American (BRLA); Genesis Emerging Markets (GSS); JPMorgan Indian (JII); JPMorgan Russian Securities (JRS) and Pacific Horizon (PHI) - which have similar discount-reduction strategies in place. Together, we are talking about several billions of pounds here.

The bone of contention is more formally called a ‘conditional tender offer’ where an investment trust’s board of directors may promise to buy back shares in the trust close to NAV at some point in the future if performance is disappointing and/or the discount is wider than a given percentage.

Conditional tender offers are controversial because they can negate one of the fundamental advantages of investment trusts’ closed-end structure - by forcing managers to sell when prices are low - and because they tend to be taken up by institutional investors - particularly activists seeking short-term gains - rather than individual investors, looking for long-term returns.

First, though, three cheers for Kieran Drake, research analyst at Winterflood Investment Trusts, who clearly sees his role as going beyond the usual house broker’s sales pitches, urging us to buy now while stocks last. On the contrary. the Winterflood team’s recent note on TEM’s plans states: ‘While it seems reasonable to provide liquidity periodically, particularly in the event of disappointing performance, we have misgivings as to the benefits of conditional tenders.

‘We do not believe that they have a positive impact on a fund’s performance or on its rating. Four of the seven funds that already have a conditional tender offer in place are currently failing the required conditions.

‘We are also wary of adopting a mechanism that may not be appropriate in five years’ time. Over that period, a fund could have seen a change of manager, investment strategy or the opportunity set in the asset class.

‘It is hard to say with any certainty what might be the appropriate course of action at that stage. We are also conscious that the mechanism does not suit private investors or wealth managers, who, in general, find it more difficult to participate in tenders.

‘Consequently, we believe that there are better courses of action to benefit a fund’s wider shareholder base.’

Laudable independence of mind, no doubt, but there may be wheels within wheels here. One shrewd observer told me: ‘What’s really unusual is that Winterfloods are TEM’s corporate broker. Why are they attacking their client?

‘Well I don’t think they necessarily are. They may well be reflecting the view of the board of TEM. The real target of Winterflood’s analysis may be City of London Investment Group -  a discount hunter or activist investor - which owns 14% of the shares and agreed to back the upcoming continuation vote on the basis of the conditional tender proposal.’

What do disinterested - but not uninterested - brokers have to say? Alan Brierley at Canaccord Genuity, did not mince his words. He told me: ‘Tender offers are rather blunt instruments, can lead the company having to sell assets at the wrong time, and will typically enable departing shareholders to realise their investments close to NAV, while providing very little uplift for remaining shareholders.

‘In addition, a conditional tender offer can attract the wrong type of shareholders, looking for a short-term uplift, and in extreme circumstances, de-stabilise the company.’

Meanwhile, independent analyst John Newlands focused on the role of investment trusts’ independent directors. He explained: ‘It is very much up to boards to ensure that private shareholders have the same opportunity as anybody else to tender their shares, and that the proposed transaction is not in reality a “done deal” before individuals are made aware and have time to participate.’

Elsewhere, Iain Scouller, managing director of investment funds research at the stockbroker Stifel, was even-handed about potential pros and cons: ‘The advantage is it gives shareholders the option of being able to exit from part of their holding at close to NAV in a few years time.

‘The trouble at TEM is we may not know until March 2024 whether the tender is going to happen and therefore why would the discount narrow today in anticipation of something that may not happen?’

Finally, for a fair and balanced assessment of the situation, I asked Annabel Brodie-Smith, a director of the Association of Investment Companies (AIC). She told me: ‘Investment companies use tender offers as a way to control discounts and manage disappointing performance.

‘The decision to implement a tender offer is taken by the investment company’s board and needs to be approved by the shareholders. Offering a tender provides reassurance to investors that if a discount is wide or performance is lacklustre the board can take steps to put it right.

‘If implemented, tender offers give shareholders the opportunity to exit the investment company if they wish to.’

So the moral seems to be that individual shareholders - and their professional advisers - need to open those brown envelopes from the investment trusts we hold and let the directors know what we want. Failure to do so would be like failing to vote in the Brexit referendum and then whining about the result. 

Full disclosure: here is a complete list of Ian Cowie’s stock market investments. It is not financial advice nor is any recommendation implied.

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