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UK Investment Trusts: Strong Governance is Fundamental to Positive Onward Trajectory

London 13th May 2024

It’s no secret – the UK investment trust market is facing some challenging headwinds.

Today, the average trust’s share price is trading at a 15% discount to its net asset value (NAV) with the volatility prompting a number of activist investors to target investment trusts, and also unleashed a flurry of M&A activity within the sector itself.

However, as Simon Gordon explains, by placing robust controls at the core of investment strategy, the sector will be in a much better place to resist the negativity:

Investment trusts v The World

Investment trusts are being squeezed on multiple fronts.

Between 2014 and 2021, £22 billion was raised through investment trust Initial Public Offerings (IPOs) and a further £50 billion was accumulated via secondary fundraising channels. Since 2021, however, this has fallen dramatically to just £40 million and £6.5 billion respectively.  [1]

It is partly because many investment trusts launched when interest rates were close to zero or even in negative territory, but now they are having to re-price lower, as rates once again rise off the back of Central Bank monetary policy tightening.  [2]

The interest rate spikes have also led to institutions – including wealth managers – to ramp up their exposures to tax efficient Gilts – occasionally at the expense of investment trusts. [3]

According to a Winterflood study, the number of investors expected to be net sellers of investment trusts jumped from 3% to 10% in 2023. The same survey found that while 63% of investors plan to allocate more to investment trusts in 2024, this is a massive drop-off from 2020-2022, when that figure stood at 80%.[4]

Regulation has taken its toll on the industry too.

EU regulations, including the Alternative Investment Fund Managers Directive (AIFMD), the Packaged Retail Investment and Insurance based Products rules (Priips) and the Markets in Financial Instruments Directive II (MiFID II) have saddled investment trusts with additional costs.

In the case of MiFID II, the way in which investment trusts are required to disclose their fees makes them appear to be more expensive than open ended funds, which has been off-putting for some cost-conscious investors.

The case for the defence

The sector is fighting back against the unfair cost disclosure rules and the irrelevant PRIIPs KID that investment trusts have to deal with.

Once these obstacles have been cleared there is reason for optimism that institutional investors will come back to the sector.  Also, the London Stock Exchange (LSE) and other industry representatives are working together to make sure that retail investors are given the correct information about costs and other factors so that they can make better informed choices about investing into Investment Trusts.

This is really vital investment democratisation.

The investment trust sector remains an excellent way for investors to access a wide range of strategies, including private companies and infrastructure assets like battery storage and wind farms.  Also, it’s worth remembering that many Investment Trusts look like excellent value at the moment precisely because of the discounts.

Investment trusts have stood the test of time, weathering economic storms and market fluctuations. Their closed-end structure provides stability, allowing fund managers to focus on long-term strategies without the pressure of constant redemptions. This resilience has attracted investors seeking consistent returns over extended periods.

Activists and consolidation in the investment trust industry

With investment trusts’ share prices trading at such heavy discounts, activists are piling into the sector, and agitating for wholesale reform, whether it be replacing senior executives and board members, exiting investments altogether, or pushing for buy backs or tender offers. [5]

Recent high-profile transactions have included Elliot Investment Management taking a stake in the Baillie Gifford managed Scottish Mortgage Investment Trust, and Saba Capital Management acquiring positions in 24 investment trusts, [6] such as BlackRock Smaller Companies, Polar Capital Technology, Schroder UK Mid-Cap, Keystone and Ballie Gifford’s Edinburgh Worldwide. [7]

Many of these activists have accumulated minority positions in investment trusts, using either leverage or derivatives, such as total return swaps.

The investment trust sector is also going through a period of aggressive consolidation.

In 2023, five investment trust mergers were announced (Octopus Renewables Infrastructure and Aquila European Renewables; Henderson High Income and Henderson Diversified Income; J.P. Morgan Midcap and J.P. Morgan UK Smaller Companies; Troy Income & Growth and STS Global Income & Growth; Abrdn China and Fidelity China Special Situations), compared to just one in 2020. [8]

In addition to generating cost synergies, consolidation is also a consequence of investors gravitating towards larger trusts. This is mainly because some of the bigger investors are worried about breaching their concentration risk limits, if they buy into smaller trusts.

This is echoed in a report by Winterflood, which suggested that investment trusts with a market capitalisation of anything less than £200 million, are at risk of becoming sub-scale. [9]

The UK Investment Trust industry spans various asset classes, from equities and fixed income to real estate and infrastructure. Investors can access specialized portfolios managed by seasoned professionals. Whether it’s investing in global technology companies or supporting renewable energy projects, these trusts offer a diverse range of opportunities

Navigating the tough markets

Investment trusts need to have robust governance processes in place if they are to avoid getting into the cross hairs of activist investors, and this is something which JTC Group – through its extensive experience of working in the listed funds space – can help with. With M&A also gaining momentum, JTC Group is well positioned to support investment trusts during transactions, through its outsourced governance and corporate secretarial solution.

The support of a high-calibre service provider is essential if investment trusts are to thrive in the current market environment.

[1] Financial News – March 1, 2024 – Why overhaul of cost disclosures is needed to revive UK investment trust sector

[2] Bloomberg – November 27, 2023 – What’s driving investment trust discounts?

[3] Bloomberg – November 27, 2023 – What’s driving investment trust discounts?

[4] Trustnet – February 12, 2024- Investment trusts sellers at an all time high

[5] Skadden – March 4, 2024 – Investment trusts and activist funds: What UK companies need to know

[6] Skadden – March 4, 2024 – Investment trusts and activist funds: What UK companies need to know

[7] Portfolio Advisor – January 2, 2024 – Saba Capital and its intentions for the UK investment trust industry

[8] Investors Chronicle – January 3, 2024 – How do last year’s investment trust mergers stack up?

[9] Investors Chronicle – January 3, 2024 – How do last year’s investment trust mergers stack up?

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