The Great Unwind

TOM TREANOR/ of Asset Value Investors explains why wide discounts can – and should – be tackled by purposeful boards.

Anyone involved in the investment trust, also known as closed-end fund, sector will spend a lot of their time talking about discounts. At AVI, as the manager of three investment trusts, all of whose strategy involves investing in assets trading at discounts, we certainly do.

The discount challenge

Discounts exist due to demand being lower than supply, an axiom about as insightful and interesting as being told “there are more buyers than sellers” when asking why a stock is going up… There is a plethora of academic research on the subject, perhaps reflecting what to many must seem at first glance like the proverbial dollar bill lying untouched on the pavement. In theory a closed-end fund with a portfolio of listed liquid equities trading at a 10% discount to the market value of that portfolio could liquidate and provide an immediate 11% gain to anyone who had bought shares in the fund.

On the face of it, this is a very simple form of arbitrage that seemingly shouldn’t exist and it’s perhaps unsurprising that many of the world’s most famous value investors began their investment careers in this area: Benjamin Graham, Warren Buffett, Edward Thorp, Seth Klarman, to name but a few.

However, in the timeless words of Yogi Berra “in theory there is no difference between theory and practice. In practice, there is”. Discounts have proved persistent in closed-end funds all over the world, so you don’t need academic theory to tell us that this must mean there are limits to this kind of arbitrage, caused by real-world frictions.

In the example quoted above, to force through a liquidation one would have to be able and willing to acquire a sufficiently large stake in the fund and then garner sufficient support from other shareholders. In situations where the underlying portfolio is a lot less liquid (say in microcap equities), the market impact of selling such securities is likely to erode at least some of the potential gains. And this is before we start thinking about funds holding private assets, where there may be no easily accessible market into which to sell.

Aside from the portfolio liquidity issue, a non-exhaustive list of why discounts exist would also include: valuation (NAV) uncertainty, large or controlling management stakes, unusual voting structures, high fees, large potential termination payments to the manager, a poorly regarded manager and/or board, and/or simply a lack of interest in the trust’s strategy.

Aside from closed-end funds, AVI also invests in holding companies, conglomerates, and Japanese operating companies with large amounts of surplus financial assets. While the unifying theme is the fact that they trade at discounts to NAV, the nature of the assets and the way that we think about discounts have different nuances across these different types of companies.

With closed-end funds, engagement and activism play a key role in our investment approach. Given our years of experience and knowledge of the sector, as an engaged and constructive shareholder we aim to add value by helping boards find ways to tackle discounts. Capital allocation is arguably the most important strategic decision taken by boards, and we firmly believe that all funds should have a clear and rational policy that demonstrates that they understand the superior returns that can usually be achieved when trading on a wide discount by preferring share repurchases over new investments.

A 5% buyback at a 30% discount to NAV, for example, provides a return on investment of 45%. Given this return is risk-free and compounds with the forward return on the existing portfolio, heroic assumptions are required for a new investment to better this.

Alternatives in the frame

The vast majority of our closed-end fund holdings are invested in alternative assets (real estate, infrastructure, renewables etc.) which, unlike equity-focused vehicles, don’t have the “easy option” of eliminating their discounts by swiftly liquidating their portfolios and returning the proceeds to shareholders. The quid pro quo for investors in the current environment, however, is that on average alternative asset funds trade at significantly wider discounts.

They offer attractive rewards for those willing to do the work to help ascertain the validity of the reported NAVs and establish in the process whether these discounts are real or illusory. The next step then is to form a thesis about how these discounts night be narrowed or eradicated and persuade the boards of the companies to take the necessary remedial action.

So, what does the playbook look like for alternative asset funds at this point?
First, some context. The nailing of interest rates to the floor in the wake of the global financial crisis heralded a 15-year boom in issuance of alternative income funds. Various shades of infrastructure, renewable energy, and sub-sector specialist real estate plays came to the London market in quick succession, followed by even more esoteric asset classes such as shipping and music rights. What these vehicles all had in common were tempting dividend yields of more than 4%, designed to appeal to investors starved of yield in the new low and briefly zero interest environment.

We are now in The Great Unwind phase of this boom. Rising interest rates, wealth manager consolidation, and flawed and misleading cost disclosure rules have led to a slump in demand, producing sharply wider discounts for these funds. The industry needs to work hard to find new sources of demand, but while there are clearly secular or idiosyncratic factors at work, a large component of the malaise is cyclical. To put it bluntly, there are too many investment trust shares around and the sector needs to shrink.

Only then, once equilibrium is restored, are we likely to see new issuance and a thriving trust market. In the case of equity trusts, Saba Capital have parked their tanks on the lawn of a large swathe of the market. While many will question the tactical astuteness of their approach when they broke cover late last year, in many instances, the complacency of boards about discounts allowed them to build their positions at wide discounts in the first place.

The fundamental and existential question that Saba with its vast pot of capital poses for the boards of equity trusts is that if you’re going to operate like an open-ended fund, then why not become one? The answer must surely mean making full use of the closed-end structure: using gearing, investing in less liquid parts of the market, buying back when on a discount to enhance returns, and so on. Otherwise, it is difficult to argue against eliminating the discount by becoming an open-ended fund, or active ETF.

Scale is also an important factor and there are many equity trust mergers that would make sense if egos and self-interest could be set aside. To their credit, many boards of alternatives funds have woken up to the new paradigm. There has been an increasing recognition, belated in some cases but welcome nonetheless, that the hurdle rate for new investments is at historically elevated levels, given the returns available from buying one’s existing assets cheaply via share repurchases.

The playbook adopted across the infrastructure and renewable funds, in particular, has been to try to sell assets close to, at, or above NAV, to prove the carrying values and provide cash that can be used to pay down expensive debt or buy back shares. Some have been more successful in doing so than others. We accept the difficulties in selling assets into a market where everyone has the same idea! This disciplined approach to capital allocation is necessary, but not sufficient, for a rerating and we think it is incumbent on boards to think radically beyond this.

Consolidation should certainly be one of the options on the table. We remain to be convinced that the sector needs three UK solar funds, for example. Boards must accept, if they haven’t already done so, that there may be potential private owners of these assets who are willing to put a higher valuation on them than public markets ever will over a realistic timeframe. While we don’t want to see boards roll over at the first approach, we do want them to recognise that reported NAVs for private assets are not seen as gospel and that shareholders will often be open to entertaining bids even if are below the latest reported NAV.

As such, we applaud the pro-activeness of the board of Apax Global Alpha in finding a solution to the persistently wide discount at which the shares traded. By running a process to establish secondary interest and a private market clearing price for the shares, shareholders who chose not to roll their investment were able to exit at a share price level unlikely to be achieved as a public company for some considerable time. In doing so, they have also provided a template for other boards grappling with entrenched discounts in the listed private equity sector to consider.

The vast majority of our engagement/activist activities are conducted wholly in private and remain so, but we were involved in an unusually high-profile campaign at Hipgnosis Songs Fund in the recent past. In our view, this episode confirmed the difference that can be made with the right directors in place, with the new appointees that we helped bring onto the board overseeing a sale of the company, a successful outcome few would have thought possible just months earlier.

Towards the future

How does this all end? We foresee, in time, a healthy bifurcated market consisting of fewer, larger, liquid funds at one end of the market and smaller specialist funds making full use of the closed-end structure to generate above market returns in less efficient market areas. The journey to get there, The Great Unwind, offers the most compelling opportunity set we can recall seeing in the London-listed closed-end fund market. And it has only just begun to run its course.

Tom was named Co-Manager of MIGO Opportunities Trust and WS AVI Worldwide Opportunities Fund in June 2025. He joined AVI in February 2011 and was appointed to the Board of Asset Value Investors in September 2017. He is a Portfolio Manager and Head of Research, working closely with the analyst team providing support and guidance on prospective and current investments across the portfolios. Tom has specialised in closed-end funds over the past 20 years, particularly in activist engagement.