Share buybacks — when a listed company buys back its own shares either through the open market or through a tender, and cancels them — were a tactic adopted by half of UK companies last year, according to Peel Hunt research.
In addition to dividends, buybacks are another way a company can return cash to its shareholders. However, several large UK-listed firms, such as Shell or BP, have been increasingly diverting capital from dividends towards large share buybacks.
Ian Lance, co-manager of the Temple Bar investment trust, attributed the rise in share buybacks to the undervaluation of UK equities and the ongoing shift of allocation by UK pension funds and wealth managers from domestic to global equities.
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“There is no wall of money coming back to the UK to take advantage of this undervaluation. CEOs are thereby taking advantage of it themselves,” he said.
Last year, housebuilder Vistry opted to cancel its dividend in favour of a share buyback, arguing it felt its stock was too undervalued to ignore the value repurchasing shares could potentially deliver for shareholders.
Share buybacks can negatively impact dividend growth in the short term. According to Computershare’s fourth-quarter UK Dividend Monitor, the UK’s underlying dividend growth would have been 7.2% — one third faster — in 2023, had share buybacks been absent.
However, Computershare has said this does not mean shareholder value is being, but rather that buybacks “represent a different way of cutting the cake”.
Some investors, such as Chetan Sehgal, lead portfolio manager of the Templeton Emerging Markets investment trust, prefer this use of surplus cash over dividends, especially where capital gains are more lightly taxed than income.
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Alongside the tax efficiency benefits, Sehgal said buybacks can bring other advantages, such as increasing earnings per share and improving financial valuations as a result of reducing the number of outstanding shares.
Moreover, by increasing demand for shares, buybacks can support the company’s share prices and lower the overall share price volatility of the security, he noted.
However, Sehgal argued share buybacks can also present disadvantages, such as reducing the free float of the company’s shares, which lowers the weight of the security in an index.
“This could subsequently result in index trackers and exchange-traded funds reducing their holdings in the company,” he added.
A tool for investment trusts
A record £4bn was returned to investment trust investors from buybacks last year in the face of persistent discounts not seen since the Global Financial Crisis, according to Numis, with increasing activity from alternative asset trusts, particularly infrastructure and private equity.
Charlotte Cuthbertson, co-manager of the MIGO Opportunities trust, said there are a wide variety of objectives behind a board’s decision to operate a buyback, including ratcheting up the NAV, narrowing the discount or removing oversupply.
For smaller trusts, however, she argued the concerns around shrinking a potentially already unviable product “plague” managers and board members.
Although reducing a trust’s outstanding shares might feel like “a big step in the opposite direction”, she argued that investment trusts on wide discounts leave themselves open to M&A or shareholders pushing them into realisation.
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On the other hand, she noted that larger trusts with bigger cash balances can find that buying back shares has a limited effect on their discount, as the overhang of unwanted shares is greater than the buyback.
“It is, therefore, important to think about the long-term aim of buybacks and whether they can be used in tandem with other corporate tools such as a realisation option,” she added.
Private equity trusts, which have historically been reluctant to undertake share buybacks, have also been ramping up efforts to narrow their persistent discounts, with Pantheon International the first to announce an increased buyback facility last year.
John Singer, chair of Pantheon International, said the majority of investors and commentators point to buybacks as the “universal panacea” to close discounts, but argued this tool is insufficient on its own.
“Relying solely on the singular goal of long-term discount reduction is a risky tactic,” he said. “A multifaceted approach holds the potential to significantly enhance success.”
According to Singer, boards should also consider other objectives, including strategic portfolio reallocation, optimising the share register, demonstrating confidence in NAV and actively reducing discount volatility.
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Moreover, he argued that relying on a one-off buyback operation, even if large, is likely to disappoint after immediate NAV gains, noting that consistently outlined regular buyback policies have the potential to enhance success.
“Knee-jerk, reactive buybacks heighten the chances of disappointment. Strategies also need to respect the balance sheet of tomorrow, given conflicting capital priorities for the sector,” he added.
“The call to do ‘fire sales’ to provide buyback cash has backfired in the past, as shareholder gratitude today can transform into ‘excessive give-away anger’ tomorrow.”
MIGO’s Cuthbertson said buybacks are not an “easy answer” to the persistent gap between NAV and share prices, but noted that with trust discounts at historically wide levels, boards and managers are under increasing pressure to use buybacks to increase shareholder value.