At a media briefing regarding the recent Wealth 50 revamp, Hargreaves Lansdown head of research Mark Dampier sounded exasperated when challenged on the absence of an entire category of funds from the influential buy list.
Investment trusts just aren’t liquid enough, argued Dampier, who was already on the defensive regarding the absence of Fundsmith from the list that’s responsible for approximately half of the direct-to-consumer (D2C) platform’s assets under administration. A recommendation from Hargreaves Lansdown could funnel tens of millions of pounds into an investment trust, said Dampier. “Tell me how many investment trusts can service that. Most trade about 1.5 million shares a day. They don’t trade £20m or £30m. Ask the discretionary managers who run investment trust portfolios, it takes them weeks to fulfil orders.”
The resulting orders could also push up investment trust premiums, a concept most retail investors don’t understand, according to Dampier, who is a non-executive director on two closed-ended funds, which he says are great products for private clients. “What happens when I say to a client, ‘You can’t buy this today, you can’t buy it tomorrow, you can’t buy it the next day’ and the price keeps going up? I’ll tell you what happens: our whole helpdesk lights up.”
Wealth 50 rivals offer wider selection of fund structures
The D2C platform giant’s stubborn refusal to include investment trusts in the buy list has prompted industry speculation about the motivations of including one type of collective over another.
Open-ended vehicles land a 0.45% annual account charge on portfolios of up to £250,000 on Hargreaves, reducing thereafter to 0.25% on up to £1m of assets, reaching 0.1% on £1-2m and falling away after that. In contrast, there is no ad valorem fee on securities, including investment trusts, plus ETFs, which are also absent from the Wealth 50, despite the inclusion of 10 passive products on the list.
“Hargreaves is really cost-effective for investment companies,” says Association of Investment Companies communications director Annabel Brodie-Smith, a compliment rarely, if ever, directed at the platform when it comes to open-ended products.
Regarding the complexity of discounts and premiums, Brodie-Smith says open-ended funds also have complicated features, such as dilution levies. “Hargreaves Lansdown’s clients have got to wonder about whether this is a satisfactory outcome; that they’re missing out just because Hargreaves is so big they’re concerned about their recommendations’ impact on the market.”
Notably, the Interactive Investor Super 60 buy list, launched the same week as the Wealth 50’s unveiling, included 15 investment trusts. Bestinvest, which followed a week later, offers 22 investment trusts among its 119 flagged funds and an additional 14 ETFs.
“It would be fair to say that agnostic platforms are likely to include all these types of assets in order to widen their appeal,” says Lang Cat founder Mark Polson, although he is reluctant to say this is the rationale behind the absence of trusts from the Wealth 50.
Interactive Investor is one of the only flat fee platforms following the acquisition of Alliance Trust Savings, due to complete in H1 2019, while Bestinvest charges tiered account service fees – 0.4% for Isas and 0.3% for Sipps on the first £259,000 – that are agnostic as to the instrument selected.
Bestinvest managing director Jason Hollands says other D2C platforms have “structures that commercially bias them towards funds by charging ad valorem fees on Oeics and unit trusts but fixed custody costs for shares and trusts”.
Investment trusts are a lower margin business
According to Hargreaves Lansdown’s 2018 annual report, revenue margin was 28% higher on funds than shares. Net revenues from funds that year totalled £198m with a margin of 41 basis points, while shares brought in £89.6m with a margin of 32 basis points.
However, that doesn’t tell the full picture, according to Fundscape editorial director Gavin Fielding, who says investment trusts are not traded as regularly as traditional equities meaning the fees revenue of that part of the business, which Hargreaves says accounts for around £6bn of assets of the platform, is likely lower.
Looking at platforms’ historical roots as either fund supermarkets or brokers highlights where investment trusts slip through the cracks, Fielding says.
The former, which includes Hargreaves Lansdown as well as Bestinvest and Fidelity Fundsnetwork, want funds inflows whereby they can charge ad valorem fees, whereas the latter, including Interactive Investor and Charles Stanley Direct, seek churn “hence they focus more on trading bulletin boards and today’s hot share tip”, he says.
Funds accounted for 56% of assets under administration (AUA) at Hargreaves, whereas at Interactive Investor, which evolved from a broker, funds represent 19% of AUA and investment trusts an additional 12%.
The fact Alliance Trust Savings had a transactional fee-based model and lost money heavily says a lot, Fielding adds. “It is not in a platform’s interests or marketing culture to include investment trusts on a buy list.”
Additionally, the transactional fee does not align with Hargreaves’ focus on using the Wealth 50 to negotiate discounted ongoing charges figures for clients, he says. The platform boasts it saves clients 22 basis points on the average Wealth 50 constituent.
Scottish Mortgage gets the cold shoulder
Portfolio Adviser put to Hargreaves Lansdown the inferences made about its motivations for excluding investment trusts from the Wealth 50 and got a short statement in response: “HL is the largest broker of investment trusts in the UK and we provide a comprehensive service for those investors who wish to hold them.”
In Portfolio Adviser’s discussions with the industry, one candidate was highlighted more than any other as exemplifying the capacity for Hargreaves to add closed-ended funds to its buy list.
“Scottish Mortgage has a market cap now in excess of £7bn. It’s a constituent of the FTSE 100 and has considerable liquidity in the secondary market,” says Winterflood Investment Trusts head of research Simon Elliott.
“Dare I say it, even the mighty house of Hargreaves Lansdown might not have any problems if Scottish Mortgage Trust was on their recommendations list with the resulting flows.” Its one-year average volume traded is £14.5m daily, according to AIC data.
Hargreaves is already the second-largest shareholder, with 8% of the company worth £560m. Nonetheless, Dampier refused to accept that any investment trust could handle the flows that come with inclusion on the buy list.
In contrast, Baillie Gifford director of marketing and distribution James Budden says Scottish Mortgage could absolutely handle the Wealth 50. “It’d be nice if investors were given the whole picture, a whole range of collective funds, closed- or open-ended,” Budden says of the exclusion of investment trusts from buy lists.
Scottish Mortgage runs regular issuance, meaning it has the scope to issue shares if Hargreaves funnelled money to it, says Elliott. “It’s a different set of considerations that Hargreaves or someone in their position would have to make, because obviously these are not things you’d have to worry about with open-ended funds, but I struggle to see how they’re insurmountable.”
The £1.4bn Finsbury Growth & Income Trust, managed by Nick Train, £3.5bn F&C Investment Trust and £3bn RIT Capital Partners, which allows retail investors to invest alongside Jacob Rothschild, are additional trusts he highlights with the scale to potentially handle Wealth 50 flows.
Says Elliott: “These are not insubstantial names. They’d all be in the FTSE 250.” The trusts had average trading volumes in the realm of £2.5m daily over the past year.
Navigating discounts and premiums
Investment trusts do require a separate set of considerations to open-ended funds before being added to a buy list, including the pricing and liquidity concerns highlighted by Hargreaves.
Hollands points to the regulatory complexities of promoting listed securities as opposed to funds. “Our ratings on trusts and exchange-traded products are not trading recommendations but reflect our assessment of management quality and the investment process, so investors do need to consider factors such as discounts and premiums, and gearing levels before purchasing an investment trust.”
The majority of closed-ended products in the Interactive Investor Super 60 have market capitalisations of £1bn or above, notes head of investments Rebecca O’Keeffe, particularly in more mainstream asset groups such as global growth (F&C Investment Trust, Scottish Mortgage), global equity income (Murray International), UK equity income (City of London) and emerging markets (JP Morgan Emerging Markets IT).
Across the universe, there are 41 investment companies with assets of more than £1bn and a further 97 with more than £500m, according to the AIC.
“Where we have included trusts with lower market capitalisations these are in what could be regarded as more niche areas of interest for private investors,” O’Keeffe says. These include the £505.9m Utilico Emerging Markets and £146.4m JP Morgan European trusts, both income products for their respective geographic regions. When a trust moves to a premium viewed as unjustifiably high, the platform flags this up.
However, O’Keeffe disputes the investment trust structure is inherently less liquid, pointing to the gating of UK direct property funds in the weeks following the Brexit referendum due to mass redemption requests. “When it comes to the crunch, investment trusts have often proven to be more liquid than their open-ended counterparts.”
Buy list exclusion symptomatic of a wider problem
Mass inflows can also cause headaches for open-ended fund managers, adds Fielding. “It would be irresponsible to put a small but high-performing trust on a buy list but just as irresponsible to cause massive inflows into a small Oeic fund where the fund manager ends up sitting on piles of cash they cannot invest quickly or at the right price.”
Scottish Mortgage is not alone in having what it takes to enter the Wealth 50, reckons Budden. “There’s no particular issue in trading on Scottish Mortgage, probably another dozen or so that fit that bill,” he says.
A spokesperson from Alliance Trust, one of the six most-traded stocks in the investment trust sector with average trading volume over the last year of £3m daily, says it “quite comfortably” accommodates current levels of demand. “Liquidity should be individually evaluated when compiling the list but is not a reason to exclude all investment trusts.”
According to Budden, the absence of investment trusts from the Wealth 50 is symptomatic of a wider problem that fund distribution lacks a level playing field.
“Five years on from the Retail Distribution Review, investment trusts still do not have the same distribution on platform, whether that’s IFAs or D2C, that open-ended funds do.
“Hargreaves is talking about liquidity here but others will mention a lack of demand. Some people have systems issues while others can’t include them in model portfolios,” he says.
“There always seems to be some kind of excuse but if you look at the demand for investment trusts, especially from D2C and, ironically, through Hargreaves, you’ll see they’ve never been more popular.”
