5th July 2022
Regular readers of our notes will know that we are passionate supporters of the investment trust sector. With Ben Conway writing and campaigning for fair treatment of OCF disclosures in recent weeks, I feel there is another big issue that needs to be addressed to arrest the diminishing demand outlook for investment trusts that is manifested in wider discounts. There are just too many sub-scale and/or irrelevant trusts languishing on wide discounts that need to be consolidated or wound up. Now I appreciate that wanting the sector to shrink might sound counterintuitive to being a passionate supporter, but it is akin to aggressively pruning a rose bush in order to generate new growth.
This issue has been around for years as institutional buyers have liquidity requirements and simply cannot invest in the smallest trusts. Fast growth in the wealth management industry over the past few years, has meant the likes of Investec, Rathbones etc can really only put the largest trusts on their buy lists. By way of basic example, if a firm running £12bn of private client money wants to include an investment trust on their Buy List for all their clients to buy, say 2% of, without owning more than 29.9% of that trust and be forced to mount a takeover bid, it can only include investment trusts that are bigger than £200m in size.
That made me do some quick research to see the differences between those trusts that have less than £200m assets, and those with more. According to Winterflood’s daily datasheet, there are 316 investment trusts (I excluded those with less than £10m of assets) that have total assets of £253 billion (a huge figure that represents about 6% of the whole UK equity market). Of those 316 trusts, there are as many as 101 each with total assets below £200m that combined are £10.8bn in size – put together would be the 40th largest company on the UK market, a material amount of money. Today they trade on an average discount of 13% compared to an average discount of 8% for the 215 trusts that are bigger than £200m. Accepting that statistics can be used like a drunk uses a lamp post – for support rather than illumination, it does suggest that the smaller the trust the wider the discount. There are exceptions of course, but at a very basic level, a wide discount implies an imbalance in demand that represents an existential threat the longer it persists.
The biggest concerns within this sub-sector are the number of conventional equity trusts that have been around for a long time, have a lot in common with open-ended equivalents and have always traded on a discount. The board of directors of those trusts should ask themselves, if this trust didn’t exist, would it be launched today? We know the honest answer, but we have a very cynical view of a minority of boards of directors who enjoy collecting their annual fees, so why would they proactively make them stop? Of course, boards of investment trusts’ primary duty is to shareholders not to themselves or the management company, so if a trust is failing to deliver on its objectives or stay relevant, then there is an obligation to take action. Of those 101 sub-£200m trusts, 11 sit in the UK Small or Mid Cap sector, so bringing a few together would not result in a radical change of mandate or loss of assets. Not all the 101 trusts are managed by boutique fund management funds either; Abrdn and BlackRock have 4 each and JP Morgan and Schroders have 5 each and so must sit incongruously amongst the billions and trillions they manage elsewhere.
It is not just the sub-scale trusts that need tackling. Those trusts that offer nothing different to what we can all buy in an open-ended fund (there is often a very similar open-ended version managed by the same management company), but with worse liquidity and more volatility, need attention too.
Corporate brokers have an important role to play in this. They have had a great time in recent years, earning fees on IPOs and secondary share issues, mainly for alternatives that have been in strong demand during the low interest rate environment. However if 2022 is a guide to future years, those IPOs and therefore fees might be harder to come by. Instead, I think they should be proactively targeting the trusts in their stable that are sub-scale or on persistent discounts and encourage boards and management companies to consolidate or change mandate or manager. If successful, this would result in corporate finance fees for the broker, a larger trust that can now attract new investors and a lower OCF usually. If done correctly, there will be no chargeable event for CGT-locked transferring shareholders. As Hot Chocolate sang, Everyone’s a Winner (but not all the directors perhaps?). There have been a handful of examples where this has worked and benefitted all involved, such as Perpetual Income & Growth and Murray Income merging in 2020 (neither were sub-scale, but it can be used as a model for how it can be done), but also more attempts that failed for all sorts of reasons.
The investment trust sector has been around for over 150 years and in more recent years has been responsible for capital flowing to essential parts of the UK economy such as renewable infrastructure, medical science and venture capital to name just three. I worry that the sleepy nature of a small, but material sub-sector, tarnishes the excellent work done by the majority. Let’s all stay attentive to the risks and help keep the sector relevant for everyone involved so it can thrive for another 150 years.
Daniel Lockyer – Senior Fund Manager
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