Getting to grips with investment trust tender offers
We examine why investment trusts go down this route and what it means for shareholders
Tender offers are an unappreciated attraction to owning investment trusts. Investors – particularly institutional ones like asset managers or pension funds – like them because they provide comfort that they will be able to sell a stake in the trust without having to worry about market liquidity (namely whether someone wants to buy the shares from them).
A tender offer is an invitation by an investment trust for investors sell them some or all of their holding. The event often happens once a year.
In order to incentivise holders to sell their shares, these tender offers are typically pitched higher than the current market price of the shares. More specifically, tenders are priced at a level which is better than the discount to net asset value (NAV) at which a stock might be trading.
According to data from industry body the Association of Investment Companies, 25 trusts carried out tender offers in 2017.
DEALING WITH DISCOUNTS
Investment trusts can trade at a premium or discount to their NAV, or total assets minus any debt. Whether they trade at a premium or a discount will depend on how popular said trust is with investors.
If a trust persistently trades at a discount it might look to address the issue and a tender offer is one of the methods employed.
For example, investment trust
Genesis Emerging Markets (GSS)
recently bought nearly 13.5m of its own shares back from investors (3 Sep) as part of a tender offer it launched in July 2018.
Genesis offered to buy back 10% of its shares at a discount of 3.5% to NAV compared with an average discount to NAV for the share price of 11% over the preceding five years.
Sometimes a tender offer will be launched in response to pressure from major shareholders, or a trust might have an explicit policy of launching a tender offer if the discount gets too wide.
This is known as a discount control mechanism or DCM, although the vast majority of DCMs are discretionary so trusts are not compelled to follow them to the letter.
WHAT ARE YOUR OPTIONS?
When faced with a tender offer, shareholders have the option of tendering more shares than the trust has offered to buy. If other shareholders have tendered less than their basic entitlement then whatever is left over can be split between those tendering more shares.
In the case of Genesis, the offer was heavily oversubscribed and, in the end, more than half the company’s shares were nominated for sale. Genesis responded by offering to buy a further 2.6% of tenders above the 10% level.
According to the investment trust team at Numis this would result in 12.4% of shares being repurchased for those holders who tendered their entire stake.
Genesis has also said that if the performance of the trust on a net asset value basis does not beat its benchmark over the five-year
period to 2021 the company will undertake a further tender offer for 25% of its shares.
Among the drawbacks of a tender offer is that it involves using capital which could otherwise have been invested and, by reducing the size of trust, it can undermine liquidity and ultimately make the fund unviable.
This was a problem faced by BlackRock Emerging Europe
(BEEP) after it saw its own 100% tender offer in June met with overwhelming demand.
More than 60% of its shares were tendered for sale, potentially reducing the assets in the fund to just £48m.
This was below a £75m threshold the company had outlined before launching the offer. It was therefore scrapped.
The company announced an alternative plan on 17 August of liquidating the trust and giving shareholders the option of receiving cash at net asset value minus costs or rolling their shares into a new class of shares in BlackRock Frontiers Investment Trust (BRFI).
EMERGING MARKETS DOMINATE
Aberdeen Frontier Markets’
(AFMC) shares persistently trade at a wide discount to NAV and it announced in July that it would launch a tender offer for 15% of its shares at 98% of the prevailing net asset value.
Winterflood’s analyst team note: ‘Equities in emerging markets have underperformed their global equity counterparts in three of the last five years and, unsurprisingly, the discount for the emerging markets investment subsector has lagged that of the wider sector in this period.
‘It is against this backdrop that £393m of capital has been returned from the subsector since the start of 2016 through tender offers and buybacks.’
Although a tender offer is one of the tools available to a trust, in the long run it needs to come up with the goods in terms of performance and market itself better if it wants to shake off a lingering discount.
Notably Genesis Emerging Markets pledged to increase marketing to existing and prospective investors alongside its offer. (TS)
Investors have been eager to take up tender offers in emerging markets funds