Board games

This article was first published in FT Adviser

In general the life of a non-executive director on the board of an investment trust is fairly straightforward, anonymous and lacking in controversy. For a few though, and for the directors of Alliance Trust over the last five years in particular, it becomes much more time-consuming, controversial and very much in the public eye.

Over the last decade, investment performance at Alliance Trust—a long-established, large and self-managed investment trust—has been disappointing, with shares tending to trade at a sizeable and relatively large discount to NAV. In late 2010, Laxey Partners, a US activist investor took a stake in Alliance Trust and campaigned for a large share buyback as a means of narrowing the discount. The Alliance Trust board opposed this and with Laxey only controlling 1.3% of the votes, a large majority of the shareholders backed the board who promised only to make use of a “flexible” share buyback programme. A key part of the board’s arguments against Laxey was the contrast between the short-term return perspective of the activist investor and the long-term return perspective of the management team and the many individual shareholders.

In April 2012, Alliance Trust gained a new Chairman, Karin Forseke, and together with CEO, Katharine Garrett-Cox, she immediately undertook a strategic review of the Trust’s activities, resulting in a seven-year plan to take the trust up to 2020.

For an investment trust with a very long history, the seven-year plan had much that was radical about it. The investment philosophy and process were transformed to focus on sustainable investments – favouring companies seeking to build responsible and sustainable businesses for the long term, consistent—it was felt—with the long-term perspective and expectations of the individuals of the Alliance Trust shareholder base.

In addition, and unusually for a self-managed investment trust, the strategic review identified two areas where a new business line could be developed that would build on the expertise already within the company. The first of these was to seek to build a third-party asset management business, Alliance Trust Investments, based on the sustainability approach that forms the basis for investing the Trust’s own assets – this was an area that was both ripe for growth in demand and where Alliance felt there were relatively few focussed competitors.

The second area was a savings platform, Alliance Trust Savings, where they saw an opportunity for growth in the wake of the UK Retail Distribution Review for a flat-fee pricing structure to take substantial market share, building on the operational infrastructure originally put in place for small shareholders in the Trust to reinvest dividends and buy shares through a regular savings mechanism.

To date the Trust has invested about £90m of shareholders assets (around 3%) in these ventures and ATI’s external assets and ATS’ assets under administration have grown in line with the intermediate targets set for them in the seven-year plan. In addition, the investment management process has been restructured to deliver the greater focus on sustainability.

However, there has not yet been a noticeable improvement in relative performance and as time passed following the Laxey Partners saga, it has appeared that the board has been less interested in pursuing the “flexible” share buyback policy. The discount to NAV has remained consistently higher than most of their competitors in the global growth investment trust sector.

In 2014, Elliott Advisers, another hard-nosed US activist investor built a 12% stake in Alliance Trust. In their meetings with Karin Forseke, they argued for the ATI and ATS investments to be discontinued and, like Laxey, for a substantial share buyback to reduce the level of the discount to NAV at which the shares traded.

The Alliance Trust board considered the Elliott proposals and concluded that though they might be in the short-term interests of Elliott, they would not be in the long-term interests of the shareholders as a whole. They thus rejected them and decided to continue with their seven-year plan.

In March this year, Elliott put forward proposals, to be voted on at the AGM in April, for three new directors to be added to the board. These three had, they said, been selected by Spencer Stuart, rather than by Elliott, and could be seen to be strong and independent figures from the financial world.

Alliance Trust shareholders became the focal point of campaigns from Elliott to vote for these new directors and from the board who were strongly opposed to the proposals, seeing them as a hostile move aimed at disrupting the company. As the date for the vote got nearer, a number of important shareholders and advisors came out publicly to say that they would vote against the board’s recommendation and for the new directors.

Following meetings with many shareholders it became clear to the board that the vote would be very close and it decided to seek a compromise deal with Elliott. This compromise saw the board agree to two of the three new directors put forward by Elliott, with the board seeking a third candidate after further consultation with shareholders, in return for an agreement that Elliott would not make any further public action or comments against the board until after the 2016 AGM.

The newly-enhanced board at Alliance Trust has a year to decide how best to balance the differing short- and long-term interests of their shareholders. The fact that the board had to accept the bulk of Elliott’s demands would appear to suggest that shareholders are losing patience with the very long-term approach adopted by the company. Over the next year, the directors will be giving considerable time to the issues facing the trust from its shareholders, with Elliott in particular putting them under pressure to boost returns for all shareholders.

Homogenised bulls

Using peer pressure to create a stockmarket rally

Currency-adjusted, Japan is the best-performing major stock market so far this year. This has continued the uptrend that began in late October of last year, a move that started with the announcement of an increase in QE from the Bank of Japan. This is the second phase of the Japanese equity bull market that was kick-started by Abe’s election victory and the introduction of Abenomics in late 2012.

That first phase saw shares rally as the currency fell sharply, government spending was boosted and an aggressive QE policy from the central bank. For the most part it was driven by foreign investors who were quick to understand the reflationary impact of these policies and their impact on corporate earnings. Japanese domestic investors were not major buyers during this phase of the market. Then from May 2013 to November 2014, the market consolidated the very substantial gains made in the prior six months.

Over those eighteen months, a number of key, interlinked, institutional changes were, however, implemented in Japan as part of Abe’s “third arrow” of structural reforms. Two of these have been crucial for the stock market and both rely heavily on the Asian concept of “face” and the strong Japanese desire not to be seen as out of line with the rest of society.

The first change has been to assert control of the Government Pension Insurance Fund (the GPIF). By insisting that it take notice of the Bank of Japan’s new inflation target of 2% and the effects of the QE programme aimed at generating that inflation and by replacing the previous chairman, the government has forced the GPIF to reconsider its strategic asset allocation, which was heavily biased to Japanese Government Bonds with negligible yields, towards much higher weightings of Japanese shares and international securities. As the leading pension fund in the country, the actions of the GPIF are carefully monitored by the other pension and investment funds in Japan and then copied, as is typical in the Japanese culture.

The second change has been the introduction of a new stockmarket index, the JPX Nikkei 400, which the GPIF is using as its benchmark for the domestic Japanese equity mandates that it is awarding as part of its move towards greater equity exposure. Membership of this index is not solely determined by market capitalisation, but also by companies’ success in implementing good standards of corporate governance together with operating profitability and, most crucially, corporate return on equity – which for shareholders is possibly the critical measure of profitability. For companies that would normally expect to be included in any list of the top 400 Japanese companies, the discovery that they do not qualify for this index has become a mark of shame.

After decades of keeping shareholder interests a long way down the pecking order of corporate priorities, the introduction of this index, and its use by the leading investor in the country, has finally produced a change in corporate mindset. For example, Amada, a leading Japanese toolmaker, was mortified to find itself excluded from the index last summer. It has recently announced that for the next two years it will pay out half of its net profits as dividends, use the other half to buy back shares and hire two independent non-executive directors by the middle of next year.

The result of these changes is a dramatic re-allocation towards equities by Japanese institutional investors – this is most likely to be seen in the new financial year which has just begun (April 1). For the first time in a generation Japanese investors are likely to become significant net buyers of Japanese shares. Simultaneously, Japanese companies finally have a good reason to be far more shareholder friendly, to make profits, to declare them as such and to reward their shareholders with dividends from those profits. This is the path trodden by many US companies over the last five years and has been very rewarding for shareholders there. It may finally be time for shareholders in Japan to enjoy the same experience.