2nd August 2024
Almost a year ago to the day, we published the 4th episode of our “We Need To Talk About Investment Trusts” series, which focussed on Capital Allocation and Corporate Activity (linked here). In the article, we discussed the various reasons why prevailing discounts were wide in the sector, whether in conventional or alternative trusts. We also offered our views on what could be done by managers, boards and brokers to help restore investors’ confidence, improve relevance and ultimately, narrow discounts. One potential remedy was increased corporate action, so it was interesting to read this week an excellent summary by the Deutsche Numis Investment Companies Research team – stating a record amount of Corporate Activity in the sector so far this year. Wednesday’s announcement of the proposed merger of the two JP Morgan Japanese trusts was another reminder of the ongoing drive for consolidation.
The Deutsche Numis note reports it has been a record year for M&A so far, and we are also on course for a record year for the amount of capital returned to shareholders. Starting with the capital returns, most of the £5.3bn given back to shareholders this year has been from share buybacks of which Scottish Mortgage’s £684m has been a big proportion. Tenders, annual redemption facilities, wind-up distributions and cash exits upon mergers are the other means of returning capital. The latter is something we have been calling for more of, as simply putting together two sub-scale trusts on wide discounts doesn’t shrink the supply of shares. So, offering a percentage of cash back must be a feature. We have seen this with the conventional trust mergers that have occurred with exits ranging from 10% to 25%. However, they have liquid portfolios where a proportion of the combined assets can easily be sold to satisfy those shareholders keen to move on. That is not so easy with the alternative trusts investing in property, infrastructure or private equity or credit – which is why there has been less activity. Some have tried and failed, and a few have been subject to bids or opted for a managed wind down strategy that will take time, so the much needed shrinkage of the alternatives space has yet to be seen.
The Deutsche Numis note reports there have been eight mergers within the trust sector in the first half of the year. Six of those have been within the same management groups, as those asset managers seek to rationalise their offerings. We have mixed emotions about the same management company mergers, although the positives outweigh the negatives. But, we will highlight them nevertheless. A positive to draw from this activity, is that it is good to see proactivity from everyone involved; managers, boards and brokers, so that sub-scale or irrelevant trusts on wide discounts disappear from the sector, replaced by larger and lower cost trusts. Regardless of which management teams are involved, it makes sense for the likes of Henderson, JP Morgan, Troy and Abrdn to focus their fund manager and sales and marketing attention on fewer trusts, and it proves doubters wrong that boards are prepared to lose their jobs to do the right thing by shareholders. Perhaps we are too purist about this, but there are some question marks around assessing whether the same management company is the best manager for the combined entity, or whether a full liquidation of subscale trusts might be a better solution for shareholders. We are not shareholders of either JPM Japan trust so haven’t been involved in any discussion, so we can only wonder how extensive the beauty parade was. Although JPM Japan Small Cap Growth & Income shareholders have been offered the chance to redeem 25% of their holding as cash, would they have preferred a 100% redemption? We know from speaking to corporate brokers that there has been lots of work behind the scenes trying to generate some much-needed fees during this IPO and secondary issuance drought, so we accept that the chance of success for merging two similarly mandated trusts managed by the same management teams is higher. Overall, if the process involved in these mergers can be demonstrated as being in the best interests of all shareholders of both trusts, and there is a shrinkage in the number of shares in issue, it should be viewed as a positive development.
The acceptance of the need for more corporate activity in the space of a year has been encouraging and it seems as though a lot of the low hanging fruit has been picked. Share buybacks are commonplace across both conventional and alternative trusts and, while we have seen plenty of conventional mergers, the consolidation of the alternatives sector is going to be harder. As the Deutsche Numis note points out, many income focussed trusts launched in the couple of years around the trough in interest rates in 2021 are no longer as attractive when vanilla fixed income generates attractive yields with lower volatility and lower counterparty risk in many cases. We have seen some takeovers in the last 12 months with LXi REIT, Hipgnosis Songs and Foresight Forestry acquired in full, but there is plenty more to do. We are engaged with boards and managers all the time to ensure they do not take their existence for granted especially if they trade on wide discounts that inhibits their prospects to grow and reach critical scale.
So the half year school report to the investment trust sector says, “Well done. Great effort so far, but don’t stop here. Keep the pace up for the rest of the year”.
Daniel Lockyer – Senior Fund Manager
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