Archive for the ‘Products’ Category

Edinburgh IT and its NAV (feat. Trustnet vs AIC)

April 10, 2009

A recent comment of mine on investment trusts at The Fool, it received a chunky number of recs:
http://boards.fool.co.uk/Message.asp?mid=11479983&sort=whole#11480217

You’re right to be put off [by Edinburgh Investment Trust].

First a point on how Trustnet measures discount/premium to NAV. Trustnet’s figures measure NAV with debt at par (nominal) value whereas others, including the AIC, measure debt at fair (market) value. For investment trusts with little or no debt this makes little difference. Edinburgh IT just so happens to be one of the most indebted investment trusts out there [1]!

The level of debt, via debenture stock, outstanding at Edinburgh leads to a large swing in discount/premium depending on how you value the debt. An idle look at the AIC’s website ([2]) currently shows a premium of nearly 10% while Trustnet shows a small discount. The AIC figure itself is misleading, imho, since it doesn’t take into account accumulated income. Edinburgh IT release NAVs daily based on par and fair value, cum and without income [3]. If this is all rather confusing the AIC have a good explanation of net asset values on their website [4].

Using March 11th as an example the Edinburgh share price finished the day at 297p, the following day Edinburgh released NAV figures that were between 270.71p and 318.39p, quite a difference! Personally I use the debt at fair value and cum income (for income ITs where this is going to skew the figure). For Edinburgh this was 282.06p on March 11th, still a premium of 5.3%.

So why the drastic reduction in discount for Edinburgh recently? Three factors stand out for me:

1. The appointment of Neil Woodford as fund manager.

2. The protection of income, in the short-term at least, that most Investment Trusts offer as they have a revenue reserve.

3. The structural advantage that a discount to NAV offers to the underlying yield – if you buy on a 10% discount you’re effectively buying a 10% higher underlying dividend (excluding charges).

2 & 3 can be applied to all Growth & Income investment trusts and most are now trading at a premium to NAV for these reasons. Personally I think its a little silly buying an Investment Trust on a 5% premium when, once the stockmarket recovers, you’re likely to see that premium become a 10% discount. For those reliant on a steady and increasing income such as retirees the peace of mind may be worthwhile but even then its difficult to justify.

I’d avoid Edinburgh right now. The downside risk is far higher than buying into Woodford’s Invesco Perpetual (High) Income funds which don’t have the leverage and aren’t in danger of reverting back to a high discount to NAV.

mm

[1] See pages 45-47 of the EDIN annual report available at:
http://investmenttrusts.invescoperpetual.co.uk/portal/site/iptrust/investmentrange/investmenttrusts/edinburgh/#

[2]AIC’s pricing for EDIN:
http://www.theaic.co.uk/Search-for-an-investment-company/Company-profiles/Conventional-companies/Performance/?company=59

[3]EDIN NAV news releases:
http://www.theaic.co.uk/en/Search-for-an-investment-company/Company-profiles/Announcements/?nav=1&company=59

[4] The AIC’s explanation of NAV:
http://www.theaic.co.uk/en/Guide-to-investment-companies/Glossary/?exact=1&filterBy=SearchTerm|Net+asset+value

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Decoding a SCARP

December 23, 2007

I’m fascinated by structured products as they effectively offer the consumer a “derivative play” in the form of a snappily branded package. The most recognisable type of structured product is the Guaranteed Equity Bond (GEB). GEBs are offered on the high street by banks and building societies and attract custom with the benefits of the stock market on the way up yet capital protection on the way down. This is an attractive mix but they are usually very poor products. Fool.co.uk have issued many informative articles about the downsides of these retail products in the past.:

http://www.fool.co.uk guaranteed equity bonds

SCARPs differ from GEBs due to the CAR bit, Structured Capital At Risk Products. SCARPs usually offer some capital protection in the form of a buffer. This buffer allows a certain fall in the value of the stock index, to which the SCARP is linked, before the investor’s capital is at risk. However, the loss can be devastating if the buffer is breached.

The now discredited precipice bond is a form of SCARP that was popular around the turn of the millennium. The main difference between older precipice bonds and modern SCARPs is a fall in the index needs to be far larger and over a longer time period for capital to be lost. Precipice bonds usually only require a 5% or 10% fall for capital to be put at risk. Newer SCARPs often require the index to fall over 50%.

SCARPs need to be looked at with a studious eye. Reading the small print is must, its a proviso with all financial products but one often ignored. While you’re unlikely to lose your capital with a high street product, with a SCARP not reading the terms & conditions could be very costly. SCARPs require a little decoding and good reading comprehension to understand them. Identifying the upside and downside of a structured product is far from simple but compared to the derivatives underneath the glossy packaging, they’re a cake walk. Here’s an analysis I performed on one such SCARP, the KeyData dynamic growth Plan Plus, at MSE.:

80% over six years is an AER of 10.3% capped.

Chance of losing money, in nominal terms is very, very low.

Post 1914 a 50% drop would have happened around 1929, 1974 and 2000-2002, so this would suggest a roughly 33/1 chance. However, there was a quick and sharp rebound in ’75 and we are nowhere near the bubble territory of 1929 or 1999. Also, a halving of the FTSE-100’s value in 2014 would put it around 1995 levels, a 20 year nominal capital value freeze has never happened, not even in the US if you’d bought on October 23rd 1929! So, its more likely 100/1 than 33/1, if I were a bookie I’d say fair odds are 66/1. Of course the old warning must be given here: past performance is not necessarily indicative of future returns.

A nominal return of capital would still be a fall in real-terms. Factoring in 4% RPI would mean a loss of 26.5% if the FTSE-100 fell <50% over 6 years or stayed the same.

The loss of dividend income needs to be factored in. A cheap FTSE tracker or equity income investment trust is going to pay out a dividend of 3.5% at the moment, so 23% (excluding dividend growth) over the 6 years. Therefore:

The FTSE-100 needs to see a capital gain of between 2.3% and 57%
or
a loss of >23.1% and <50.1%
for this SCARP to do better than a tracker over the six years.

The tax situation of the SCARP should be beneficial for most people, i.e. those who don’t have a Capital Gains Tax liability and can use up their allowance. Important to realise that the capital gains will be realised in the year of maturity so putting >£11,500 in would mean going over the current personal CGT allowance of £9,200 if the value of the FTSE-100 rose 8%+ in the six years. Of course the government could tinker with the tax rules and make the above meaningless.

Frankly, it looks a decent product to me. I think its worth a good look if you:
1. Are using your 7K ISA allowance.
2. Are paying a fair amount into a pension.
3. Want a relatively high return with some capital protection.
4. Don’t have the expertise to make use of the CGT allowance.
5. Aren’t prepared to pay an IFA for that expertise.
6. Are currently paying income tax on a large chunk (say 10K+) of change in a deposit account that you know you will not need in the next 6 years.

Note: I’m ignoring the 4%pa ‘bonus’ since you only gain interest for a few weeks before the money is invested, they don’t pay out until a week after the maturity period either. I’m also ignoring the stated 3% commission since this seems to be built into the calculations Keydata give.

See also:
http://business.timesonline.co.uk/tol/business/money/article1009900.ece