20th October 2023
We believe the investment companies sector is in crisis. Any practitioner that operates in the sector will tell you liquidity is abysmal and even the smallest amount of selling pressure sends shares spiralling down. As I type, there are multiple companies whose share prices are down over 5% for no discernible reason. We have highlighted multiple times how we believe a significant factor is the current cost disclosure regime. In addition, we have also written about how the sector can help itself – see the compendium of our series (here).
Sadly, as you may have noticed, many companies in the sector have been suffering from self-inflicted wounds, and given the backdrop, share prices have been reacting especially badly to instances of dividend cuts as a result of poor balance sheet management to give one example. The topic of this blog is not these companies (we will return to them once we are in possession of all the facts and the situations are less ‘live’). However, we would like to highlight how corporate governance might be improved – especially since our series on the sector ran out of space to cover one particular angle. We ask, “are non-executive directors paid enough?”
There have been too many instances, particularly involving investment companies that hold alternative assets, where share prices have deviated too far from NAV despite the assets in question being of excellent quality. Too often better corporate governance could have headed off the issues causing these discounts to open up. Is the pool of non-executive talent to fill Boards as deep as it should be? We also wonder whether the requirement for the majority of a Channel Island-domiciled investment company’s Board to be Channel Island residents restricts the talent pool too much?
Investment companies that hold assets other than equities and bonds are far more complex and require many different skillsets. Additionally, the time involved in ensuring the companies are run optimally, and investment advisers overseen properly, can be significant. The Board needs expertise across investment company structure, corporate strategy, accounting, tax, law and most importantly knowledge of the assets being invested in. Often the assets in question may need financing and a realisation of the limitations of the investment company structure (when equity financing is essentially impossible when share price is below NAV) is absolutely vital. Far too often investment companies run into problems because they IPO-ed on the premise equity financing would be available – at least on a periodic basis.
Are current levels of remuneration sufficient to adequately reward Directors for the time needed to protect shareholders? And even more pertinently, are levels of remuneration high enough to attract the talent required to ensure value isn’t destroyed despite a company holding good assets? The evidence increasingly suggests the answers are “no” and “no”. Tangentially, it is appropriate to also ask whether Boards are being appropriately advised and getting value for money? Boards can only be so big. From time-to-time expertise from outside needs to be brought in and paid for, and the role of the company’s broker is crucial. Shareholders are right to ask the question whether Boards are solely to blame for poor corporate governance.
The issue of appropriate Board remuneration brings us back to the cost disclosure topic. Higher levels of board remuneration would lead to higher ongoing costs. We live in a world of scrutiny over every basis point. It is a crying shame. The constant pressure to keep fees as low as possible will have a detriment on investment returns if skill and talent are not rewarded properly. It is even more frustrating that we believe investment company costs should be disclosed but not aggregated in the total cost figures of the portfolios that own them. If directors were paid more, this would be discounted in the share price. I would go so far to say that it might even boost share prices: although ongoing costs would be higher, investors would come to understand that with higher director salaries comes better candidates and investment companies that are run far more optimally for shareholders.
Ben Conway – Head of Fund Management
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