Bill Jamieson: Discount dilemma for Katherine the Great

Published on Sunday 18 April 2010 21:42

WHEN Alliance Trust chief executive Katherine Garrett-Cox unveils annual results from Britain's biggest investment trust today, at least one major investor is no longer being lured by her charms.

Edinburgh-based Personal Assets Trust (Pat) has dumped its chunky 14 million investment in Alliance after failing to persuade the Dundee-based giant to take action over its persistent discount to net assets. It is the third big investor to sell out or reduce its holding in the past year.

Investment trust discounts – the gap between the share price and the underlying value of the trust portfolio – have been one of the most problematic features of this asset class.

Shares in Alliance currently stand at 346.2p. But the underlying portfolio, if sold today, would fetch 430.9p per share. Such is the size of Alliance and the nature of the portfolio that the discount represents the largest uncrystallised value in the entire sector. The discount of 19 per cent to underlying value would, if closed, enhance shareholder value by more than 400m.

The persistence of this discount has been a source of concern at Alliance for years, and the gap, if not narrowed, could render one of Scotland's largest companies vulnerable to a predatory takeover bid. It could point the way to a bigger dividend pay-out today to narrow the gap.

Pat, the iconoclastic trust which has a cult following among many high net worth investors in the sector, is now managed by Sebastian Lyon of Troy Asset Management following the death of the legendary Ian Rushbrook two years ago. It acquired its large holding in Alliance in October and November of 2008 when global stock markets were suffering one of their worst collapses in living memory.

The shares, Pat believed, "offered the potential upside should markets rally (as they did] but Alliance also gave the added prospect of a tightening of the discount".

Here Pat was to be sorely disappointed. According to the latest investment report from Troy Asset Management, Pat "engaged the new management at Alliance in a debate on the problem of investment trust discounts". It considered Alliance as an ideal candidate for a discount control mechanism, and "with the discount worth 400m for shareholders, there is substantial value to be unlocked for the benefit of the trust's owners.

"Regrettably, management could not be persuaded of these merits. We have therefore used the opportunity presented to us by stronger markets to take profits and sell the holding in its entirety."

While this is part of a concerted reduction of exposure to equities by Troy ahead of a feared stock market relapse, the exit of Pat will set the cat among the pigeons and re-open debate across the industry as to whether Alliance is tackling its discount problem with sufficient vigour.

Discounts can be brought down and the share price raised by management buy-in programmes such as that put in place by Pat. It can also be substantially reduced by superior capital performance, or by raising the dividend.

Alliance's annual results should show a further recovery in capital performance – it is almost fully invested in large capitalisation stocks with just 1.5 per cent held in money market funds.

However, despite substantial holdings in big dividend-paying shares such as BP, HSBC, British American Tobacco and Royal Dutch Shell, Alliance shares are yielding an unexciting 2.35 per cent.

Alliance has rejected commitment to a full-blown share buy-in programme. But it has made two opportunistic repurchases in the past year. The first was last October when it bought in 15.6m worth of shares, prompted by the sell-off of sharers by Norges Bank Investment Management. The second was last month when it spent 19.7m buying in shares after publisher DC Thomson put part of its stake up for sale.

While Alliance can argue that the discount has come down from a peak of 25 per cent in the autumn of 2008, it is still among the highest in the investment trust global growth sector.

By contrast, shares in Baillie Gifford-managed Scottish American Investment Trust are standing on a discount of 9.9 per cent, Monks Investment Trust, another Baillie Gifford fund, is on a discount of 14.6 per cent and Martin Currie Portfolio Investment Trust is on a discount of 6.3 per cent.

Keen attention will thus be focused on Garrett-Cox today and how she intends to address the discount dilemma.