Now that many investment trusts trade at a premium to their net assets value, it has become commonplace for them to issue more shares so as to “meet demand” as they tend to say. The latest example of this is at Finsbury Growth & Income Trust Plc (FGT) which is one of the better performing trusts. Other examples of those who do it regularly are City of London Investment Trust and City Merchants High Yield Trust.
In the case of Finsbury they are calling a General Meeting for the 1st July to approve the allotment of up to 10% of the existing shares. The circular gives a number of justifications for this large potential share issuance such as the improvement in liquidity in the shares, to help management of the discount/premium, increasing the size of the company spreads costs over a larger base, and it enhances the NAV per share. It also helps to support those investors who regularly buy shares each month without looking at the price.
They do mention the potential dilution effect on dividends and assure us that they will take steps to ensure there is no material dilution. But they fail to mention one of the big potential problems – namely that there is historic evidence that the bigger investment trusts or mutual funds become, the worst their performance tends to be. They tend to revert to the global mean. John Bogle has pointed out the evidence on this in his books.
They also don’t mention the other possible motivation for increasing the size of a fund. Namely that it normally increases the fees payable to the manager whose remuneration usually has an element based on a fixed percentage of the total fund value (0.6% in the case of FGT). So one might not be surprised if the fund manager recommends or supports share issuance.
Limiting the premium might help new investors. But why should existing shareholders support the issuance of more shares? They should be perfectly happy if the share price goes to a significant premium over NAV. So it does not seem to this writer that there is good reason to vote for the resolutions at the forthcoming General Meeting.
Who is the Chairman of Finsbury? Anthony Townsend who has been on the board since 2005 when he “rejoined” according to the last Annual Report. Two other directors have also been on the board since 2000. They might be sympathetic to the desires of the fund managers perhaps after such a long association? ShareSoc has highlighted the problem of having directors on the boards of investment trusts for too long (for example at Baronsmead VCT 3 where Mr Townsend is also a director).
In conclusion, issuing more shares when an investment trust trades at a small premium to net asset value is not necessarily a good thing. The premium might naturally be limited as discounts tend to be. When share prices become illogical in relation to assets held, they tend to be self correcting. So investors in these companies that have a penchant for pumping up the size of the trust might wish to consider how they vote for such proposals.
Whether an increase in the fund size will cause problems depends on how big the fund is and what it invests in. Also even if the management costs scale with the size the other administrative costs probably don’t, so the TER will generally fall. And some trusts have a smaller management fee on assets over some level. I wouldn’t usually oppose this kind of resolution – but then again I’m not invested in the high-yield funds which currently tend to sit at a premium because they don’t seem especially good value anyway. You say that shareholders should be happy for shares to go to a premium – in a sense that’s true, but my reaction would generally be to sell and switch to an equivalent OEIC!