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Jenson Holmes, a trainee adviser with Ravenscroft, explains why investment trusts are addressing undervaluation through record levels of share buybacks
In recent years, investment trusts have encountered significant challenges, including an unfavourable interest rate cycle and “misleading” cost disclosure regulations.
These factors have driven almost all investment trust sectors to trade at substantial discounts to their net asset value (NAV) compared to historical levels. Despite slight improvements over the past year, the industry still trades at an average discount of 16.2%.
Higher interest rates have particularly impacted investment trusts, affecting asset valuations, especially in property and infrastructure.
This along with higher yields – which has meant shifting investor preference toward cash or bonds – has caused troubles in the investment trust industry.
With interest rates now entering a cutting phase, investment trusts are gradually becoming more attractive, although share prices have yet to react significantly.
Real yields have so far remained elevated, and managers have therefore taken proactive measures to address the persistent discounts seen in the market.
A new record in September 2024 highlighted the undervaluation of UK markets, especially in investment trusts. During that month, 120 trusts repurchased a portion of their own shares, setting a record since data collection began in 1996.
This activity contributed to the £5.4 billion in share buybacks within the first nine months of the year, a significant increase from previous years.
This isn’t just happening in the investment trust industry either; almost 40% of FTSE 100 companies bought back their own shares at some point during the course of last year.
The high volume of buybacks across the UK market indicates that company boards recognise the undervaluation of their shares, offering reassurance to investors and signalling potential capital growth.
Share buybacks have both strategic and financial purposes, benefiting companies, trusts, and shareholders.
By reducing the number of outstanding shares, buybacks increase earnings per share (EPS), which then enhances the appearance of the company’s profitability.
They also provide an alternative to dividend payments for returning capital to shareholders using any excess cash on the balance sheet.
Most importantly, share buybacks enhance shareholder value by ultimately supporting and driving share prices, especially when they are initially trading at a discount to NAV.
The effect of carrying out share buybacks is up for debate in many different circumstances, but it is expected that we will see increased merger-and-acquisition activity in the coming months, which could provide an additional boost to shareholder returns.
Identifying opportunities in the sector remains challenging due to the undervaluation throughout the industry.
However, looking ahead, sectors like renewable energy and infrastructure may particularly benefit from the anticipated more favourable interest rate environment over the coming years.
These sectors have yet to experience any recovery compared to others that have seen moderate improvements, offering potential opportunities for capital growth.
