4 lessons for Investment Trusts post Patient Capital

This article was first published in Investment Week

The news that Neil Woodford’s new vehicle, Woodford Patient Capital Trust plc, has raised more money at launch (£800m) than any other UK closed-end investment company in history provides an opportunity for the industry to re-establish itself in the eyes of many investors as a suitable repository for their savings. In order to achieve this, however some lessons must be learned.

Lesson One: Investors will buy closed-end funds when the structure adds value to their portfolio and is the appropriate one for the underlying investments.

The illiquidity of the fund through the unquoted nature of the majority of the fund’s expected portfolio meant that an open-ended vehicle could not be countenanced. The private equity investment trust, which Patient Capital is closest to in nature, has a well-established history and pedigree in the UK market and though the share prices of these vehicles have proved to be volatile in the short term, the fact that they provide long term fixed capital to managers has enabled many to deliver excellent long term performance. Only those investors who lose patience and sell their shares at discounted prices in difficult market conditions stand to miss out on the longer term performance.

In recent times investment companies investing in other specialist less liquid asset classes such as very small listed companies, property and loans, have also taken advantage of the closed-end structure.

 

Lesson Two: Investors will buy closed-end funds when there is a strong and trusted brand.

Woodford is an eponymous brand that has very strong recognition amongst private investors, and most importantly, a high degree of trust. There are few in the UK fund management industry who have made so much money over such a long time period for so many investors.

Recent media stories of pay in the asset management industry now outstripping pay in investment banking, combined with the rise of the passive investment industry attacking the performance of active managers, have been damaging to the image of the industry, as have the Financial Times’ surveys showing that sexism is rife within asset management companies.

 

Lesson Three: Investors will buy closed-end funds when the fees are attractively constructed.

Woodford has hurled a huge stone into a large pond that was already experiencing some ripples. There is no ongoing asset management fee at all (though there is an ongoing expenses charge capped at 35 bp). The manager will be remunerated exclusively through a performance fee of 15% of any performance above a hurdle rate of 10% per annum – 80% of this fee will be paid in shares priced at the prevailing NAV. These are terms that treat the underlying investor well compared with many other private equity vehicles.

It is clear that Woodford’s interests are well aligned with his investors. In today’s world of disappearing bond yields, zero fees before a 10% return is achieved, is very attractive to a retail investor. Morningstar’s position on performance fees is that, where they are appropriate at all, they should be tied to lower than normal fixed fees so that the manager has some hunger to achieve the performance necessary to earn a performance fee. Performance fees are most appropriate where returns are skewed towards alpha rather than market beta.

Investment company fees were already under pressure from the increasing prevalence of platform and super-institutional or super-clean share classes amongst open-ended funds. Both existing investment companies and future new launches need to look hard at their fee structures to ensure they are appropriate for this new environment. Woodford’s attractive fee structure has undoubtedly contributed to its successful launch.

 

Lesson Four: Investors will buy closed-end funds when there is a credible Board with the appropriate skillsets.

Patient Capital has four Directors, all non-executive and all with substantial experience of managing or investing in early stage innovative businesses in healthcare and technology. These are highly relevant skillsets for overseeing the type of portfolio that Woodford is seeking to build with the £800m raised at launch. From the biographies in the Prospectus, none of the Directors have, however, had any previous experience on the Board of a listed investment company nor do any of them appear to be a qualified lawyer, both of which are unusual.

An ideal Board has the asset class or sector experience to quiz the manager stringently, an accountant for the Audit committee, Board experience of other investment companies, and legal experience should controversies arise.