The Board of Directors can create programmes of investment trust share buybacks. This would usually be done to trusts where the shares trade at a large discount to net asset value.
The board must be granted permission by shareholders before they can begin. This is normally a relatively long procedure since the resolution would need to be agreed by a shareholder vote. This vote would usually take place at the annual general meeting, meaning that information about the proposal would need to have been submitted with the trust's annual report. In other words, it might be six months (or more) from the time the Board of Directors first discusses the matter until an approval by shareholders is granted.
Often, though not always, a desire to buy it's own shares would suggest that there is an oversupply of shares in the trust in the market. Buying back shares - in effect cancelling them - can boost performance all round.
When the discount premium of an investment trust falls too far (above 15% and perhaps as far as 30% in extreme cases) predators will start to circle the fund, smelling money in the air!
Finding ways to
narrow the discount between price and net asset value then becomes of
paramount importance to the fund manager. The narrower the discount
becomes, the less instant profit there is to be made by any predator
fund or organisation that may try some form of hostile takeover.
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Firstly, by buying and cancelling shares, existing shares become more
valuable as there is the same amount of assets held by a smaller number
of shares. Secondly, it can represent excellent value for money. Some
discounts will be as wide as 25 percent and this means that every 75
pence spent on a share buyback actually purchases 100 pence of assets.
In addition to spending the money well, a more limited supply of shares may help to push prices up slightly and reduce the discount - this is excellent news for existing shareholders. If the fund pays an annual dividend, the dividend yield may also be enhanced (there may now be the same amount of income coming in and less shares to distribute between).
In April 1999, ACT or Advance Corporation Tax, was abolished. An investment trust share buyback became much more tax efficient.
As they are quoted on the London stock exchange, the FSA lays down some guidelines for an investment trust share buyback, which include:
- a trust must not pay more than 5 percent above the market price to purchase it's own stock
- the board can seek approval to purchase no more than 14.99 percent of trust shares at any one time
- the money for purchase must come from the capital of the investment trust - this must be the same money that would otherwise be used to purchase an investment
This well written research document argues that many investment trusts should take action to reduce their discount to NAV by using buybacks more effectively.
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