Annabel Brodie-Smith: Rare activity emerges in investment trust M&A

UK equity manager Harry Nimmo spies a match in Dunedin Smaller Companies

It’s hard not to sing along to Frank Sinatra’s famous words “Love and marriage, love and marriage go together like a horse and carriage.”

In these days of quickie divorces and couples happily living together, without a mention of marriage, this all seems rather out of touch. But the UK’s divorce rate in 2017 is now at its lowest level since 1973, so perhaps there’s still something relevant about marriage today. And the benefit of a marriage has been recognised by many a business.

In the UK despite economic worries, M&A had the strongest first quarter in the UK for a decade. However, when it comes to investment companies, mergers are relatively rare so it’s interesting that there’s a high-profile merger currently on the table.

Standard Life UK Smaller Companies which is managed by the well-known smaller company manager, Harry Nimmo, is looking to merge with Dunedin Smaller Companies.  Both these companies are managed by Aberdeen Standard Investments, the product of a megamerger of the two management groups, Aberdeen and Standard Life. Successful mergers are usually with two companies managed by the same management group and a hostile bid from a rival investment company is rarely successful.

The shareholders of Dunedin Smaller Companies have already voted in favour of the merger and we do not have to wait long as the Standard Life shareholders vote on 3rd October. All being well dealing in shares in the new merged entity will start on 10th October.

So what are the advantages of a merger for investment company shareholders?

Well when it comes to liquidity size matters. So it’s going to be easier to deal without influencing the share price in a bigger more liquid investment company and this is an important consideration for wealth managers.

Every year, Winterflood asks the buyers of investment companies, “what is the smallest size of investment trust in terms of market cap you would consider investing in?” Every year the number prepared to deal in a company with a market cap below £100m goes down from 62% in 2016 to 55% in 2018. And every year more buyers want to invest in a company that’s at least £200m in size from 3% in 2016 to 13% in 2018.

Simon Elliott of Winterflood explained: “This reflects an increasing preference for larger funds, particularly from larger wealth managers, who, as a result of their growing size, are struggling to justify exposure to smaller investment trusts. This is a result of potential liquidity requirements in the secondary market, with size being a good indicator of liquidity.”

Another big benefit to shareholders of a merger is the potential for a reduction in costs.  Investment company boards have been proactive on costs with over a third reducing costs since 2013. Of particular significance to a merger, has been the trend to introduce tiered fees which pass on economies of scale to shareholders as the fund grows in size. In the first half of 2018, ten investment companies introduced tiered management fees and this marks a noticeable increase from the same period in 2017 where five companies introduced tiered management fees.

It’s encouraging to see independent boards, a key benefit of the investment company structure acting in shareholders’ interests in this way. Shareholders in a merged bigger company, with tiered fees, would benefit from a reduced fee.

Costs are inevitable in any merger and who pays for what is an important part of the deal and they clearly need to be kept in check.

Of course, whether it’s a merger or any corporate event, performance is a key priority for shareholders and the track record of the manager of a possible merged entity will be analysed in detail. It may be that all going well a newly merged investment company can generate strong performance, have lower fees and be larger and more liquid. These features would broaden the appeal of an investment company and may lead to a narrower discount.

Now that really would be a marriage made in heaven for shareholders and Frank Sinatra would have something to sing about.

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