It’s been a tricky time for the world of investment trusts in recent weeks. We all know that most things in the world of asset management are cyclical, and sentiment towards the sector can be added to that list.
In recent weeks the headline-grabbing news has been focused on governance at the largest trust in the sector, Scottish Mortgage. More broadly, the proposed combination of the wealth management division of Investec with Rathbones has highlighted the potential risk that ongoing consolidation poses to a sector where liquidity is becoming more of a focus. It has also been a fairly barren time for the IPO market, although we did break the drought last week with a £30m raise by Ashoka White Oak Emerging Markets Trust. Whilst it’s always positive to see another addition, it will be a long road before it reaches a suitable scale for larger investors. Lastly, we might question whether the trust sector is keeping up with the needs of clients when it comes to responsible investment preferences.
Before we dig into some of these topics, it is worth reflecting back just two or three years to when the sector was flying high. In 2020 investors were favouring trusts for a number of reasons. The Woodford experience had clearly highlighted the need for illiquid assets to be in a closed-end structure, and there is an irony that Scottish Mortgage is being described by some as the next Woodford. Investors had also seen the benefit of being able to hold reserves by those more income-focused trusts versus their open-ended equivalents, allowing a smoother income profile when dividends fell off dramatically in 2020. IPO’s were also flying off the shelves, with everything from infrastructure to music royalties and space- focused private equity at the more niche end of the spectrum.
There is a certain irony to this given, in my view at least, investment trusts are head and shoulders above their open-ended equivalents in this regard. That’s not to say all is well in the space. We actively engage with the boards of all our key investment trust holdings, and it is fair to say some are held in higher regard than others. Without focusing too much on the specifics of this one trust, we do have a strong view on the tenure of board members, an area we would like all trust boards to limit to nine years. More broadly, the other issues highlighted at Scottish Mortgage, whatever your view, are unhelpful to the space as a whole.
Moving on to the combination of our peers Rathbones and Investec, this must represent a further challenge to the space. Both are significant holders of investment trusts and their combined assets will inevitably challenge their ability to invest in smaller trusts and may limit participation in even the largest trusts. BH Macro, the hedge fund vehicle, appears to be the standout example, where the combined entity owns over 30%, normally the level at which a formal takeover might be required. Bearing in mind that the trust has a market capitalisation of around £1.7bn, this is no tiddler. That may be the exception, but our own analysis shows several large trusts where the combined entirety owns over 15%. The ability to add significantly would appear to be crimped, and for the sector that’s a concern. There is a one clear message: growing the size of investment trusts is increasingly important, and mergers such as those seen by JPMorgan Global Growth and Income are going to be increasingly important. Interestingly, comments I’ve heard from market participants suggest that there is an increasing number of trusts investigating new options this year, so we will see whether that results in an increasing rate of change later in the year.
Of course, it isn’t only the investment trusts that are impacted by a merger such as Rathbones and Investec. The challenge of owning very large proportions of open-ended funds is a real one. Some have gone down the route of sub-advised mandates, which in itself reduces the size of retail funds. We continue to have far too many open-ended funds in existence, and plenty are sub-scale. This potentially adds to that problem.
Perhaps this is the start of things to come after the sixteen-month hiatus, although clearly at that size it will have a long way to go before it reaches a size where institutional investors are able to fully participate.
The lack of trust IPOs has also had another impact, which has been that the space has lagged open-ended funds in offering options for clients with a focus on responsible and sustainable investment. There are of course exceptions, and in areas such as renewables it has a strong presence. However in the long-only equity space, bar a handful of mandate changes, trusts tend to be behind the open-ended universe in offering suitable options. Our own experience of the focus of both boards and underlying managers has been that they lag as a group, and that may become an increasing impediment in coming years.
We started by talking about cycles, and I don’t doubt that we will continue to see sentiment towards investment trusts ebb and flow, whilst they remain an important option for investors in the UK. We have focused our attention on engaging with boards and will shortly be publishing a paper on our findings. When we talk to boards, we are often surprised how few of our peers spend time engaging with boards unless the sort of headlines produced by Scottish Mortgage are written and would encourage others to be more active. Ultimately ensuring best practice in the space is to the benefit of all shareholders.
This is a marketing communication and is not independent investment research. Financial Instruments referred to are not subject to a prohibition on dealing ahead of the dissemination of marketing communications. Any reference to any securities or instruments is not a personal recommendation and it should not be regarded as a solicitation or an offer to buy or sell any securities or instruments mentioned in it.
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