Page 9 - DIY Investor Magazine - Issue 25

The high score for the largest bracket is due to one trust, BMO Commercial Property Trust, which sits on a 50% discount to NAV, reflecting the extreme uncertainty in the commercial property market; if property sectors are excluded the relationship is even stronger.
Not all small trusts trade on wider discounts than their larger peers; demand can be strong for some that have carved out a niche, allowing the examples below to grow into large ones by issuing shares while trading on a premium.
Nevertheless there are reasons a smaller trust might trade
on a wider discount; the inability or unwillingness of certain buyers to get involved, smaller marketing budgets leading to lower awareness even if performance is good and the strategy differentiated, and higher charges could all be factors.
LIQUIDITY
One of the few disadvantages of closed-ended funds relates to smaller funds; a smaller trust has less liquidity in the shares, whereas an open-ended fund depends upon the liquidity of the underlying investments in the market – small open-ended funds can be just as liquid as larger ones.
This averaged data masks wide dispersion; there are plenty of trusts with more modest spreads at a lower size, but a greater risk that the spread could widen in adverse circumstances, highlighting the importance of understanding the liquidity of a small trust and being selective.
PERFORMANCE
So, do smaller trusts offer a performance advantage to compensate for the extra discount and liquidity risk? We found no such advantage, in fact the larger trusts from five years ago have outperformed since then on an NAV total return basis.
This chart shows that the average five year return was c. 6.12% annualised for the entire AIC universe; returns on average were much weaker for those under £100m at the beginning of the period and there is minimal difference for the other age bands. Poor returns for the sub-£100m trusts reflects a couple of factors.
Low stock liquidity and trading volumes can become self- fulfilling for some smaller trusts, and is a reason for them to trade on a wider discount; if selling is more costly, it stands to reason that an investor would demand a greater discount to the value of the assets when buying Large, professional investors may be less willing to take stakes they cannot be sure of unloading at a good price; this can also lead to wide bid-offer spreads, further deterring investors.
Liquidity is measured by the average amount of shares traded each day, whereas what most investors are interested in is
the cost of buying and selling; it is therefore perhaps best measured by spreads, as in the graph below.
Again, the investment trust universe in £100m brackets up to £1bn, then the average bid/offer spread as a percentage of the mid-price; the reduction in the cost of buying and selling is dramatic until the £400-£500m bracket, then it continues to generally decline, but at a slower rate.
9 DIY Investor Magazine | Sept 2020