The Big Theme
Alliance Trust, the UK's largest investment trust and a core holding in many investors' portfolios, is facing mounting pressure from one of its larger shareholders, hedge fund Laxey Partners, to deal with a raft of problems including poor performance, an ineffective buy-back campaign and its discount to net asset value (NAV)
What Laxey proposes
Alliance Trust's NAV performance over three and five years is below the average of its peer group (global growth investment trusts), placing it among the weaker performers in the sector. The same is true of the share price performance. Laxey says there have been five calendar years of consecutive underperformance relative to Alliance's chosen comparator index, the FTSE All World Index, to the year ending 31 December 2011.
Consequently, it has put forward a number of proposals for a vote at Alliance Trust's annual meeting on 27 April. Basically, it wants a review of the company with the aim of improving investment performance and discount to net assets, and possibly including the replacement of the current investment team - led by chief executive Katherine Garrett-Cox - with external managers. It also wants a system enabling shareholders who wish to sell their ordinary shares to do so at a price which more closely reflects NAV."
Laxey has past form when it comes to Alliance Trust. In November 2010, Laxey Partners sent an open letter to the board of Alliance Trust proposing a control mechanism to limit the discount to 10 per cent below NAV, and changes to how shares held by the Alliance Trust Savings Scheme could be voted.
Alliance duly started making share buy-backs for the first time in its 124-year history at the end of 2010, following pressure from Laxey. But after initially tightening, the discount has widened again and is now around 15 per cent, according to Morningstar data.
In April 2011, Alliance Trust decided to remove the share voting mechanism, while continuing to oppose Laxey's resolution. At last year's annual meeting, around 70 per cent of shareholders voted against the two resolutions requisitioned by Laxey Partners. Read more on this and the result
Laxey is also concerned about Alliance Trust's costs and queries its total expense ratio (TER). While Alliance Trust says its TER is 0.65 per cent, making it one of the cheapest investment trusts in the global growth sector, Laxey alleges that this ignores cash drag from two of Alliance Trust's loss-making subsidiaries - Alliance Trust Savings and Alliance Trust Investments. "By consolidating the two, we calculate that the cost of managing Alliance is 50 per cent above the stated company cost and 24 per cent higher than the weighted average of its externally managed peer group," says Laxey. "We calculate the consolidated TER is 0.98 per cent versus 0.79 per cent for the market cap weighted average of its externally-managed peer group, which is excessive particularly given the continued poor performance of Alliance."
Morningstar puts Alliance Trust's TER at 0.81 per cent.
"The level of TER depends on the methodology used to calculate it," says Simon Elliott, head of investment company research at Winterflood. "Where we take particular exception with Alliance Trust is the fact that it is not including the costs of its subsidiary businesses, although it is standard industry practice for investment trusts not to count this." Winterflood says the subsidiary businesses need £2.5bn in third-party funds to break even.
Laxey says outsourcing the management contract for Alliance Trust would result in a lower annual fee which, if allied to a performance fee, would protect shareholders from excessive charging in falling markets and would incentivise the manager to maximise the return to shareholders in all market conditions. "Internally-managed investment trusts are now very much the exception as it dramatically reduces the board's options when analysing asset performance, rating and costs," Laxey adds.
Performance fees can raise the TER and some argue that it is ridiculous to give fund managers an extra reward for doing the job that they are already contracted to do. However, a Laxey spokesperson says the fixed annual fee would be much lower and in bad years no performance fee would be paid on top. The spokesperson points out one of the best-performing global growth investment trusts, Murray International, has a performance fee. Despite that, its overall TER is still very low – 1.07 per cent – partly because the basic management fee is only 0.5 per cent.
Since Laxey proposed its annual meeting resolutions, Aberdeen Asset Management, which runs many investment trusts including Murray International, has publicly said that if Alliance Trusts' management contract was outsourced it would be highly interested in bidding for it, and has suggested it could cut costs. But Alliance Trust's board says it has not been formally approached by Aberdeen.
Dividends and discounts
As well as calling for arrangements to enable shareholders to sell their shares at a price close to NAV, Laxey thinks Alliance Trust should raise its dividend, taking advantage of changes in investment trust rules which have come into effect this April. Investment trusts can now pay out realised capital gains as dividends, in addition to their revenues, which enables them to pay higher dividends. Laxey believes that Alliance Trust's discount would tighten if it availed itself of this facility.
"By way of example, assuming [Alliance Trust] distributes all the 2011 earnings per share as well as the realised capital gain via dividend, shareholders could receive dividends of as much as 28 pence per share (equivalent to a 7.6 per cent yield), which is more than triple the current revenue-only derived dividend," argues Laxey.
Laxey says a higher dividend would be more effective than share buy-backs and cost less than the ones conducted last year.
Alliance fights back
Alliance Trust is vigorously contesting Laxey's latest proposals and urging other shareholders to vote against them. It says the requisitions are costing the trust more than £2.5m, and that Laxey is acting in short-term self interest. Alliance says it is narrowing the discount via improving investment performance, share buy-backs and a continuing emphasis on sustainable dividend growth, and discount volatility has narrowed. Since the start of 2011, Alliance Trust has bought back 80.6m shares worth £291m and equivalent to 12 per cent of the share capital.
The trust has also recently raised its dividend by 7.2 per cent and maintains that its TER is one of the lowest in the sector.
"This persistent requisitioning wastes shareholders' money and demonstrates Laxey's short-term attitude to its investment," says Karin Forseke, chairman of Alliance Trust. "The board believes strongly that this resolution is not in the best interests of all shareholders. Alliance Trust remains focused on improving investment performance and last year delivered strong results. It is crucial that all shareholders make their voices heard and vote at our AGM on 27 April - and we strongly urge them to vote against Laxey's resolution."
Alliance Trust adds that performance has improved significantly since last year's AGM, such that the trust has outperformed its sector group by 2.4 per cent.
It says managed trusts are on average cheaper than outsourced ones. The average TER for the global growth trusts is 0.97 per cent, but if self-managed trusts are removed the average TER would be 1.04 per cent.
What the brokers say
Last year's intervention led to Alliance Trust consulting widely with its shareholders. This produced a clear message: sort out the discount, which in turn led to an active buy-back programme. But what do analysts say about the latest developments?
Winterflood Investment Trusts does not believe that increasing the fund's dividend will improve the discount rating and disagrees with Laxey's suggestion that realised capital profits should be used to increase the dividend. "We believe that, as a rule, funds should be wary of converting capital into income."
Analysts at stockbroker Oriel Securities concur: "Playing around with dividend payouts is smoke and mirrors in our view, and this change in company law, which takes effect from April, could potentially have a negative impact on holders of debentures issued by investment companies in terms of their cover, as well as muddying the waters for investors who historically have been content to focus on earnings per share.
"Although Alliance Trust's dividend yield is relatively small at around 2.4 per cent, it has managed to grow it consistently over time. If the board were to increase the dividend target as suggested by Laxey, it would run the risk that the unblemished record of having raised its dividend for each of the past 45 years could be shattered in one fell swoop - should capital gains in a given year, which are notoriously hard to predict, disappoint."
However, Oriel Securities shares Laxey's view that a more strictly defined discount control mechanism would have resulted in fewer shares having to be bought. They comment: "The only sure way to narrow the discount in our view is to introduce a publicly stated discount target or regular tender and/or for the trust to rebuild its long-term performance record. Until that time, or unless the discount widens significantly from 16 per cent, we would sooner pay up for those funds with a demonstrable long-term record."
Oriel suggests that investors switch into Murray International. But, although this trust has a tremendous performance record, it trades at a premium to NAV. Read our tip
Alliance says allowing shareholders to sell close to NAV is not in the interest of long-term shareholders, rather these mechanisms typically deliver one-off benefits that favour shareholders looking to exit rather than those looking to support long-term value generation.
However, a Laxey spokesman said that it has been a shareholder since 2009, so it is not short-termist, although he admits that if Alliance Trust's discount narrowed to around 10 per cent it would probably sell its stake.
So is Laxey likely to succeed in its mission? Unlikely, say analysts, considering that it only holds around 1.7 per cent of Alliance Trust's shares. That said, other major shareholders who backed them last year may do so again – these include US hedge fund Elliott Associates, which owns around 3 per cent of the shares.
What we think
We shares analysts' concerns over using investment gains to fund higher dividend payouts. There is already a mechanism - the revenue reserve - that allows steady dividend growth over long periods, and this has generally served investment trusts very well.
More pro-active discount control via buy-backs would be welcome, but there is a limit to what discount control mechanisms can achieve. Part of the appeal of investment trusts is that the market, not the managers, set the share price. Deep discounts are a reflection of market sentiment and can offer opportunities if you buy at the right time.
What Alliance really needs to sort out is its investment performance, which as Laxey points out, has been poor. An improvement here would do far more to narrow the discount than either a control mechanism or a change to dividend policy.
Alliance Trust is not one of our preferred global growth vehicles. We do like Murray International, but it trades at a hefty premium. Other favourites in this space include
Alliance & Murray compared
ALLIANCE TRUST (GB00B11V7W98)
|AIC SECTOR||Global growth||NAV||434.7p|
|FUND TYPE||Investment trust||PRICE DISCOUNT TO NAV||-15.29%|
|MARKET CAP||£2.13bn||1-YEAR PRICE PERFORMANCE||1.85%|
|YIELD||2.45%||3-YEAR ANNUALISED PRICE PERFORMANCE||13.64%|
|SET UP DATE||21 April 1888||5-YEAR ANNUALISED PRICE PERFORMANCE||2.42%|
|TOTAL EXPENSE RATIO||0.81%||MORE DETAILS||www.alliancetrust.co.uk|
Performance data as at 10 April 2012.
MURRAY INTERNATIONAL INVESTMENT TRUST (GB0006111909)
|AIC SECTOR||Global Growth & Income||NAV||926.97p|
|FUND TYPE||Investment trust||PRICE PREMIUM TO NAV||6.47%|
|MARKET CAP||£1.13bn||1-YEAR PRICE PERFORMANCE||7.51%|
|No OF HOLDINGS:||65*||3-YEAR ANNUALISED PRICE PERFORMANCE||22.10%|
|SET-UP DATE||18-Dec-07||5-YEAR ANNUALISED PRICE PERFORMANCE||12.73%|
|TOTAL EXPENSE RATIO||1.07%||MORE DETAILS||www.murray-intl.co.uk|
Performance data as at 10 April 2012
Activist investors - troublemakers or a force for good?
Activist investors were fairly active before the financial crisis, but since then there has been far less activity. They are typically value investors who build up a large enough shareholding in a company to enable them to put resolutions to the board to bring about change. In the investment trust sector they have often targeted trusts on a wide discount to NAV or that are performing badly, looking to close the discount or sometimes wind up the trust and distribute the proceeds to shareholders.
Not surprisingly, these value shareholders are disliked by investment trust boards, but others argue that they are helpful to smaller private investors who do not hold enough shares to take such action.
"They have shaken out investment trusts that are underperforming and at a discount to NAV, achieving change and better performance," says Simon Elliott, head of investment company research at broker Winterflood. "But if you want a long-term investment from your investment trust, they can put this at risk as their actions can result in the wind-up of a trust."
Activists "are generally a force for good, but it is hard to generalise," says Tom Tuite Dalton, analyst at Oriel Securities. "They keep boards on their toes, but certainly in Alliance Trust's case the interventions are costing money. However, if Alliance Trust's performance had been in line with its sector, this would not be necessary."
Active shareholders can target companies other than investment trusts, for example Cookson, which has put positive changes into effect following pressure from hedge fund Cevian Capital. Read IC columnist Alistair Blair's comment on this
Laxey and 3i
Laxey has also recently put proposals to the board of private equity investment trust 3i Group. Laxey wants 3i to stop making new investments and return capital to shareholders – proposals expected to be debated at the annual general meeting in July.
The proposals include:
• No new investments until 3i is no longer on a discount to NAV.
• Existing investments realised in a timely and orderly manner.
• Net cash proceeds from disposals returned to shareholders.
• Reduction of the total expense ratio (TER).
3i has only responded with the following: "We note the letter from Laxey Partners. The board will give it proper consideration and continue its practice of engaging with shareholders."
3i has underperformed its peer group (private equity investment trusts that invest directly, both in terms of NAV and share price over one, three and five years) at times massively. It trades at a discount to NAV of around 32 per cent.
During the market downturn in 2008, its share price fell by 73 per cent and chief executive officer (CEO) Philip Yea left. The balance sheet was refinanced and under the new CEO, Michael Queen, debt and costs were cut. But, although 3i's share price recovered over 2009 and 2010, in 2011 it plunged 44 per cent on a total return basis, and the discount widened from 1 per cent to 38 per cent. Mr Queen has now announced his departure.
"With the fund's strategy appearing to change on an annual basis, it is no great surprise that shareholders have become impatient," say analysts at broker Winterflood. "Michael Queen was very successful at cutting the level of debt, but the investment business is damaged. Returning capital to shareholders over time would undoubtedly see the company re-rated and it is a path already trodden by other funds in its peer group such as SVG Capital. However, by ceasing new investment there would be a question over 3i's future, specifically its ability to manage third-party money and raise new funds."
Alex Child-Villiers, a Laxey spokesperson, admits that this strategy would result in 3i becoming a much smaller investment trust, but that this is a fairly natural cycle for private equity investment trusts.
"A managed liquidation strategy is being pursued by other listed private equity companies with a better track record than 3i, such as Candover, Conversus and LMS, while others like SVG Capital and Dunedin Enterprise are making partial returns of capital," comment analysts at investment bank JPMorgan Cazenove.
Mr Child-Villiers also said they are not calling for a wind-up of the trust – but this could result from such a strategy.