Conceptually, the value of a portfolio of investments is the sum of the value of its comprising elements. Therefore, a common shorthand approach to value an investment holding company is to compare the market value of the company (its share price) to the sum of the value of investments that it holds less any liabilities (its net asset value). However, this equation rarely balances and differences are so prevalent that academic researchers have produced more than 2 500 papers investigating the phenomenon with at least 450 papers published on the matter since 2020 alone.1
In South Africa, we are very familiar with investment company discounts, where the discount of Naspers to the value of its underlying assets is a recurring topic of debate. The attempts by Naspers to reduce this discount are commonly used methods, including unbundling underlying investments, increasing listing visibility and buying back shares. Whether these attempts succeeded in reducing the discount to any material degree is a matter of opinion. Nevertheless, the Naspers case is only one illustration that, whenever an investment holding company trades at a discount to its net asset value, management is pressured to reduce it.
In recent times there seems to be a greater sense of urgency amongst management teams to implement and communicate decisive strategies to reduce investment holding company discounts. Partly, this is due to increased shareholder activism, but the perception that investment holding company discounts persist and are increasing in size over time is also a significant contributor. Not all management teams follow the same discount reduction strategies and, interestingly, different companies sometimes follow directly opposing strategies. This is perhaps unsurprising, given that thousands of academic research papers have yet to reach consensus on exactly why discounts of a given size arise, much less on how to deal with these. However, considering the case of three investment holding companies from around the world offers some interesting points for investors to mull over in the interest of informed decisions (leaving the nuances of the debate for the academics).
Close to home, Remgro Limited is seen as the Rupert family’s main investment vehicle, holding investments in various industries such as food producers, private hospitals and telecommunications. The company’s strategy to reduce the discount to net asset value is based on the premise that the discount should narrow if Remgro offers the only listed entry point into the underlying companies. As such, in recent years, Remgro has been unbundling some listed investments (e.g. Grindrod, RMB Holdings) and delisting others (e.g. Mediclinic, Distell). However, as Chart 1 shows, the company’s discount to intrinsic net asset value has not exhibited a clear trend since the end of 2017. Apart from a widening of the discount during the global pandemic of 2020, the discount at the end of March 2024 was not dissimilar to levels observed during 2018.
Turning to the UK, RIT Capital Partners plc, offers an interesting comparison. Founded originally by a scion of the Rothschild family, this investment holding company (specifically termed an “investment trust” in the UK) traded at a reasonably stable premium of around 10% to intrinsic net asset value prior to the advent of the 2020 pandemic. This was traditionally attributed to the company’s track record of successfully identifying fledgling companies that eventually grew into large listed enterprises. Like Remgro, Chart 1 shows that RIT Capital Partners lost this premium during the pandemic and has been trading at a discount ever since. However, its management team has diagnosed the problem as holding too much of its investments in unlisted ventures (which are difficult for outside investors to value). As a result, in direct contrast to Remgro, the company’s strategy to reduce the discount has been to switch a greater proportion of its underlying investments to listed securities. Combined with a substantial buyback of shares, management believes that this will reduce the discount over time.
The other company illustrated in Chart 1, Investor AB is listed in Sweden and is associated with the Wallenberg family. While mainly holding investments in the medical field, Investor AB also holds interests in telecommunications, banking, other financial services and industrial equipment manufacturers. While 68% of its investments by value are listed, Investor AB also controls substantial operating subsidiaries and has a large venture capital portfolio. Similar to the other companies, Chart 1 shows that the premium to net asset value at which Investor AB traded before 2020 changed to a discount during the pandemic years. However, in contrast to Remgro and RIT Capital Partners, the pricing of Investor AB largely recovered and the discount was around 3% at the end of February 2024. And management’s strategy to reduce the discount? Answer: they do not have one. By simply focussing on what the management team does best (making good investments), the reward has been greater trust by shareholders and a reduced discount to net asset value over time. This also reflects in the comparison in Chart 2, where Investor AB, the company that most successfully reduced its discount to net asset value in the years since the pandemic, is also the company that grew its intrinsic net asset value the most over this period. Importantly, Investor AB’s intrinsic net asset value also grew faster than the Swedish Equity Benchmark (SIXRX) over one and five years.2
Although this might be an oversimplification of the issue (witness the thousands of academic papers on the matter), a basic takeaway appears to be that the best action that management of an investment holding company can take to reduce a discount to net asset value is to focus on its core business, being the performance of underlying investments. Other actions that management may take (such as unbundling investments or share buybacks) can never be more than complementary strategies. In this respect, investment holding companies should be selected for a portfolio using the same process that you would use to evaluate and choose a discretionary asset manager. In other words, the discount to net asset value does not matter; the management team’s ability to add investment outperformance does.
And now for my solution? Dismantling the investment holding company entirely (by unbundling or disposing of all investments and returning the money to shareholders) is guaranteed to make the discount disappear. Of course, the discount will crystallise as a loss for the shareholders (at least partially and perhaps wholly) as fees will have to be paid to dismantle the structure. However, there will be no discount afterwards because the investment holding company will no longer exist. [I know, but I did warn you that making the discount disappear would be my trick for the day…]
1 Data from a Google Scholar search for the exact term: “Closed-end fund puzzle” as at 1 May 2024.
2 Growth in Investor AB’s accounting net asset value (which is typically lower than intrinsic net asset value due to accounting rules), also outperformed the SIXRX over one, five, ten and twenty years.