Share buybacks may herald a new era for investment trusts

With only a few weeks of 2024 remaining, how will the investment trust industry look back on 2024? Well, this year may well be remembered as the year of the share buyback – record numbers of funds have bought back their own shares since the beginning of 2024, and often in record amounts.

The figures are remarkable. In September alone, reports investment trust analyst Winterflood, 120 trusts bought back shares, more than in any month since records began almost 30 years ago. Winterflood says investment trusts bought a total £5.4 billion worth of their own shares in the first nine months of the year – that was another record sum.

The explanation for this phenomenon is straightforward. Facing a variety of tough headwinds, most investment trusts have seen their shares slip to wider discounts relative to the value of their underlying assets over the past 18 to 24 months. Investment trust boards have therefore intervened to confront this challenge, which is to their credit.

In theory, buybacks should bring discounts down. As an additional buyer of the stock, the fund increases demand for its shares; and the trust then cancels the shares, which reduces supply. The stock then looks more attractive to the rest of the market, with the fall in supply boosting earnings per share and net asset value per share.

In practice, however, share buybacks don’t always deliver – and certainly not straight away. The value of the buyback programme may not be sufficient to shift the demand and supply balance in favour of the trust. The programme may be seen as a short-term measure that does not address underlying problems at the fund.

Buybacks may even lead to investors selling more stock – to take profits from any short-term uplift in the share price, say, or because they see the initiative as indicative of wider malaise.

Certainly, trusts pursuing buyback programmes have seen mixed results. Scottish Mortgage did see its discount narrow after an unprecedented £1.01 billion worth of share buybacks, though it subsequently began to widen again. But Winterflood’s analysis of ten investment trusts in different sectors that have conducted buybacks this year found only six of them subsequently traded at a lower discount than their sector average.

Nevertheless, share buybacks are widely regarded as one of the most powerful weapons that investment trust boards possess. And there is quite strong evidence that even over short-term periods, buybacks can help reduce the volatility of a fund’s discount, which is important to many investors too.

The hope then is that the fund can build on its new-found stability to get its discount down and to keep it down.

In reality, when market sentiment is depressed, everything an investment trust board does is akin to fighting with one arm behind its back. And the past year or two has certainly been frustrating for investment trusts.

A perfect storm of factors, from concern about funds’ size, risk profile and charges, to a trend for investors to favour passive funds over actively managed vehicles such as investment trusts, has been difficult to contend with.

Above all, investors of all shapes and sizes have steered clear of any asset they considered to be riskier – a bracket that investment trusts are often swept into.

Still, there are reasons to be optimistic. Economic conditions have shifted, with inflation under control in most Western markets, and interest rates now falling. A year of elections is almost over, easing some political uncertainties. Stock markets have largely performed well, assuaging investors’ anxieties.

For all these reasons, it is now much easier to be upbeat about the outlook for investment trusts. In which case, the action that boards have taken on buybacks and discounts may begin to deliver more tangible results, particularly if funds stick with these programmes. That may mean 2024 turns out to be more than just a year of buybacks – it could also mark a turning point in the investment trust sector’s fortunes.

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