A 'Darwinian' process of corporate action and shareholder scrutiny has long prevented the UK’s investment trust universe from getting bloated. The sector consisted of just 395 closed-ended funds at the end of June, according to Association of Investment Companies (AIC) data. By contrast, UK investors have thousands of open-ended funds to choose from.
Unsuccessful trusts do not tend to survive for long. Those that underperform and fail to build up a good level of assets or appear to lose their relevance tend to face the threat of closure. Purges of the sector can often occur at times of crisis, with many names shutting amid the financial crash. Survival rates can reflect this fact: of 326 trusts that launched between 2000 and 2009, 272 have not survived in their original format, according to Numis analysis.
As the chart above shows, trusts that launched since 2010 have fared much better so far. However, a combination of the current crisis and broader structural trends could now prompt another clear-out, with big consequences for shareholders. Any such changes should bring benefits for private investors, but also raise important questions about which trusts you should be backing.
The shake-up
The investment trust sector has already witnessed a great deal of change in 2020, especially in some areas considered to be niche. Shareholders recently voted against the continuation of Gabelli Value Plus (GVP) and Secured Income (SSIF). The board of the former must put forward plans to wind up, reorganise or reconstruct the trust, while Secured Income will be wound up with cash returned to shareholders. Notably both boards had urged shareholders not to pass the continuation vote, a recommendation also recently made by the board of JPMorgan Brazil (JPB). Separately, the board of Aberdeen Frontier Markets (AFMC) proposed a voluntary wind-up this year after the trust failed to meet a performance target. Other names, including Henderson Alternative Strategies (HAST), are in the process of winding up.
The industry also witnessed a less common occurrence at the end of July, with the news that UK equity income trust Perpetual Income & Growth (PLI) would merge with Murray Income Trust (MUT), subject to shareholder approval. The PLI board, which had been seeking a new investment manager to replace Mark Barnett, said a merger would offer “exposure to [Murray Income manager] Aberdeen Standard Investments’ UK equity strategy in a well-managed and enlarged investment trust with a highly competitive management fee”.
Finally, the onset of the recent crisis and broader trends could spell trouble for several other trusts. Numis analysts have warned of “a similar wave of corporate action following Covid-19 as happened post-financial crisis, when the relevance of esoteric mandates and small, underperforming funds is reassessed”.
They added: “185 investment companies have a market cap of less than £200m and we believe that many of these need to focus on staying relevant to investors. In addition, many larger investment companies have limited trading liquidity and undifferentiated strategies, meaning that they can easily fall off the radar.”
The Numis team has pointed to several trusts with upcoming continuation votes that could face an uncertain future, in part because of their limited size. These include Jupiter UK Growth (JUKG), BlackRock Income & Growth (BRIG), ScotGems (SGEM), Highbridge Tactical Credit (HTCF) and Jupiter Green (JGC). All of these trusts recently traded on notable discounts.
On a separate note, some other trusts could be open to potential changes. The board of Temple Bar (TMPL) is currently reviewing its options after investment manager Alastair Mundy went on long-term sick leave.
Lessons for bargain hunters?
A wave of corporate action can ultimately be good news for shareholders in many respects, because a wind-up will offer a way out for those feeling disgruntled with poor performance. The options available can vary, and it can be important to decide what might suit you best. In some cases, investors will be able to move into another fund, while other wind-ups may result in cash being returned to shareholders. Investment trust shares may even make gains on the news of a change, potentially giving you an opportunity to exit beforehand.
“The bottom line is it’s a good thing for investors. They can get out with cash. You can either take a cash exit at NAV plus costs or go into an open-ended fund run by the same group. It’s normally a good thing,” says Simon Moore, director at Trust Research.
The longer-term effects should also be positive, because any clear-up should ensure that the trusts on offer remain relevant and well managed. But the threat of closure may well give valuation-minded investors pause for thought when it comes to picking niche, or out of favour, investment trusts.
There are several characteristics to consider when weighing up whether to back a trust. Those with a market capitalisation of significantly less than £100m may look threatened, although this alone is not a sign a trust faces an existential crisis: smaller names with strong appeal can grow gradually through demand.
One warning sign can come down to costs. Mr Moore notes that funds in mainstream asset classes with charges above the 1 per cent threshold may look unattractive, adding: "It’s better to have larger funds and a total expense ratio of 1 per cent is no longer acceptable: 0.65 per cent is the norm and Scottish Mortgage is on 0.36 per cent.”
Some leeway can be applied in niche areas and other traits, such as a trust's longer-term appeal and investment strategy, may well hold greater sway with investors. But high costs can still be a red flag.
“If you’re looking at which fund to buy, charges shouldn’t be the be all and end all,” says James Carthew, head of investment company research at QuotedData. But he adds: “It’s more relevant when you have tiny trusts and you get charges creeping up to above 2 per cent.”
Mr Carthew more generally disagrees with any perception that small trusts are “a waste of time” and should be avoided at all times. But he does suggest that smaller names need to stand out to survive, and a trust with a notable offering may have greater longevity. He notes that Golden Prospect Precious Metals (GPM) was viewed in some circles as too small to continue but has since delivered handsome returns because of its focus on the likes of gold and silver equities.
As such, anyone considering bargain hunting for investment trusts should take a view on how competitive a trust is. Does it stand out against the competition in terms of how the portfolio is run, both in the closed and open-ended space? If its fees look high or its discount looks wide shareholders should carefully consider what might change the situation, from a review of its charging structure to a change of focus or investment manager, or even a shift in sentiment towards the trust's investment universe. It is also important to think about how relevant the portfolio is to investors, both now and in future. If investors were to embrace more of a total return focus, for example, income trusts could lose some of their allure.
Merger territory
As noted, the proposed merger of PLI and MUT is highly unusual, in part because trust boards have other options available to them when dealing with performance problems. They can usually first seek a new investment manager or simply wind up if the portfolio is liquid enough to do so.
“Mergers are very rare,” says Mr Moore. “To have a takeover being successful both sides have to want it, including fund managers, shareholders and directors. I’ve seen aggressive takeover requests fail many times because the target company doesn’t want to be taken over or it’s not profitable enough to warrant it. What’s more common is a change of manager.”
However, when mergers do happen they can often be beneficial for existing shareholders, because the resulting trust can be bigger and more liquid. This can also potentially result in greater economies of scale and fee cuts for investors.
In such cases, as with "rollovers" from closing trusts into other funds, it is worth assessing what the change will mean for you as a shareholder when deciding how to vote.
In the case of the recently announced merger plans, for example, MUT offers a lower dividend yield than PLI. However, PLI’s board has argued that MUT has a “more resilient portfolio income profile” than the market, and an intention to keep raising dividends over time. The MUT portfolio has performed better than PLI in both net asset value and share price terms in recent years because of the former's focus on quality growth stocks. On the other side of the equation, MUT shareholders would benefit from a lower ongoing charge if the merger went ahead.
This form of consolidation can also make trust shares easier to trade. Numis analysts have noted that mergers of recent years, including that of Medicx into Primary Health Properties (PHP) last year and Dunedin Smaller Companies into Standard Life UK Smaller Companies (SLS) in 2018, have resulted in more liquid vehicles.
The emergence of larger investment trusts might also benefit shareholders across the sector if it persuades more investors to use closed-ended funds and pushes up valuations.
“There are some big names that can carry the torch for the trust industry, such as Scottish Mortgage,” says Mr Carthew. “In UK equity income it was City of London. With Murray Income you have a new one, with a marketing budget behind it, that could persuade investors in.”
A flurry of merger and acquisition activity continues to look unlikely, with management changes and wind-ups appearing more realistic. But it is worth noting a handful of cases where fund management groups run more than one investment trust in the same market.
Numis, which put together the figures shown in the chart above, has argued there could be “scope for consolidation” here. It is notable, for example, that Aberdeen Standard, itself the result of a merger, runs four UK equity income trusts. Of these, Dunedin Income Growth (DIG) and Murray Income have a good level of overlap.
