2014 – A year of change for investment trusts

The ripples from the implementation of RDR at the beginning of 2013 brought investment trusts under the scrutiny of a broader audience of advisers and investors this year. As a result, investment trust boards have begun to understand there is an opportunity to make their funds more attractive for both existing and potential new shareholders.

Lower fees
The simplification and reduction in fee structures across the sector has been a marked trend in 2014, as the competitive pressures from ‘clean’ share classes meant investment trusts have shifted from being cheaper than open-ended funds to being more expensive, as advisers’ trail commissions are a diminishing feature of the marketplace.

Examples of investment trusts reducing fees in 2014 included: Perpetual Income and Growth, Schroder Income Growth, and Montanaro European Smaller Companies.

Greater attention to managing the discount to reduce share price volatility was also evident. It is the volatility of the discount which has historically been one of the factors holding back adviser interest in investment trusts. Both Martin Currie Global Portfolio and Jupiter Green have adopted a zero-discount policy. There is a psychological effect that operates here, as the very existence of such a policy acts to keep the discount lower and less volatile.

Income-focused trusts have been proactive with their dividend policies, with some moving to quarterly dividends to provide a more regular stream of income to their shareholders. Brunner has a 40-year record of consecutive dividend increases, and now delivers that through more frequent cash flow, which has great appeal for income-conscious, retail investors.

Perhaps the most dramatic example of an investment trust board seeking to become more relevant to the changing UK marketplace has been at British Assets. The board has jettisoned a traditional equity mandate and investment manager in order to pursue a multi-asset income strategy targeting capital preservation and income growth – this is subject to a shareholder vote in January.

A closed-end structure lends itself well for this, given there is no need to deal with inflows/outflows, and the ability to save some income in revenue reserves and use it to smooth dividend pay-outs in leaner years.

Pension changes
This move is in response to the change in pension rules on annuities from April 2016, as an asset with low volatility providing income that grows over time is likely to prove a very appealing substitute to an annuity.

New capital raising in investment trusts was concentrated in two areas (see table, below). In general, new issues came in less liquid asset classes, better suited to the closed-end structure. Areas such as infrastructure, distressed debt, environmental, solar, and property led the way.

Many of these fitted the second theme of income – sustainable yield is in increasingly short supply in financial markets, and new sources of investment income are in strong demand.

Box showing new capital raising in investment trusts

Corporate activity
Across the industry, discounts have been fairly stable though they have been a little spooked in recent weeks by signs of weaker economic growth in Europe and China. They remain, however, at historically low levels and, unnervingly, at levels last seen in 2007, just before the financial crisis.

The low level of discounts has meant relatively muted corporate activity – Edward Bramson’s assault on Electra was, and remains, somewhat surprising, given its superior long-term track record and small discount relative to the sector.

Meanwhile, 2014 saw the sector say goodbye to Jupiter Second Split, Prosperity Voskhod, CQS Rig Finance, Dexion Trading, and BlackRock New Energy, among others.

Board scrutiny
In 2015, we are likely to see a continuation of more scrutiny from boards to make their propositions relevant for today’s investors, a greater focus on fees and simplicity of fee structures, and better transparency and communication with investors. The change to annuity rules will see more investors seeking diversified sources of yield.

The Financial Conduct Authority’s focus on the wealth management industry is also likely to lead to greater consistency of holdings across clients within the same firm. This is producing more heavily policed approved holding lists, which in turn demands greater liquidity for any individual trust to make it onto such lists.

The pressures on smaller trusts (below £100m and arguably below £200m) from this change of emphasis amongst the wealth management industry is beginning to exercise the minds of boards, and a greater appreciation of the benefits of economies of scale is occurring, which may lead to merger activity.

On the regulatory front, attention should be paid to the success or otherwise of the AIC’s campaign to get ESMA to change its proposal that would currently make every investment trust a complex product for MiFID II purposes.

Were this to go through it would mean advisers would have to consider investment trusts as more risky investments than individual equities, and likely lead to far less investor interest.