A range of mergers have been announced in the investment trust space in recent times. Among others, the £2.3bn JP Morgan Global Growth and Income trust announced plans to absorb the £71m JP Morgan Multi-Asset Growth & Income (MATE) in January, while last week saw a bidding war break out between Custodian Property Income Reit and Urban Logistics for the £198m Abrdn Property Income Reit.
Meanwhile, Winterflood released its annual survey of its clients earlier this month, which showed that some 64% of respondents believe more investment trusts should actively pursue consolidation, up from 45% last year. Among the reasons given, many argued that the sector contains too many small, illiquid funds.
At the time of the MATE merger announcement, chair Sarah MacAulay raised concerns over the trust’s market cap, saying that the board had been conscious for some time that MATE’s “relatively small size” reduced its appeal to investors. “Unfortunately, size does matter due to the implications for costs and for the liquidity of MATE’s shares,” she said.
So, is consolidation a good thing for the trust sector, and do smaller trusts have a choice other than to pursue a takeover?
“A number of factors have contributed to increased consolidation, but one of the main reasons is that trusts which have lost their ‘relevance’ have fallen into a no man’s land where they cannot find a core appeal to any group of investors,” says Hugh van Cutsem, partner at Kepler Partners.
“Selling pressure brings widening discounts and therefore makes a trust’s future uncertain. Consolidation is one route to ensure a longer life. Key though is that trusts have a strong core investor base in their new guise, otherwise they are just kicking the can down the road.”
“Small and illiquid trusts certainly are an impediment to many investors,” he adds. “However, if they have a mandate that appeals to retail investors and a board and manager that are actively engaging with these investors then smaller trusts can thrive. For example, both Rockwood Strategic (RKW) and MIGO Opportunities Trust (MIGO) are quality, well-managed trusts with a market cap of less than £100m.”
See also: AIC: Trust purchases turn negative for the first time since 2011
Nick Greenwood, who co-manages the £79.3m sized MIGO trust, argues the increased amount of mergers is a ‘survival of the fittest’ scenario.
“The investment trust sector constantly evolves and the rule of natural selection is alive and well. Whether a trust is vulnerable to consolidation will depend on what audience it is playing to,” he says.
“Traditionally the natural buyers of trusts were the private client stockbrokers. Most of these have merged into the wealth management chains. These have become vast, managing many billions of client money which means that it is now difficult for them to buy enough shares in even quite large trusts to move the needle. A trust which is mainly owned by these chains is likely to struggle unless they are sizeable.
“Conversely the new natural buyers of trusts are high net worth individuals, small wealth managers who have broken away from mainstream advisers and retail investors. These don’t need the vast scale and welcome the flexibility the manager has running a smaller portfolio. It is perfectly possible for some smaller trusts to thrive at the same time as certain larger trusts find themselves without a future.”
James Carthew, head of investment companies at QuotedData, also highlights widening discounts as a significant driver in increased trust M&A. According to the Association of Investment Companies website, the average trust currently trades at a 10.96% discount.
“Boards are more proactive than they have been, which is good news,” Carthew says. “However, more cynically we could argue that advisers – short of lucrative IPO income – are looking for alternative ways to generate fees. Generally, it is healthy that weaker funds are absorbed by more successful ones.
“This Darwinian environment helps remove the dead wood and is one reason why trusts tend to do better than open-ended funds over the long run.”
Retail Investors
The role of retail investors can also play an important part in the future of smaller investment trusts. Recent research from the Association of Investment Companies showed that private investors now own 23%, or £41bn, of all investment trust shares.
“Retail investors are becoming ever more important as an investor group within closed end funds, with funds of all sizes. Small trusts will now not be purchased by many DFMs for a myriad of reasons. Retail investors can be far more flexible, to their benefit, and therefore will look at and invest in smaller trusts,” says Kepler Partners’ Van Cutsem.
“Boards and managers have to be able to clearly and consistently state their purpose and investment case. We will likely see more trusts disappear that fail to appeal – this is an inevitable part of the sector’s evolution. But investment trusts are a fantastic structure for so many reasons and so the sector will continue, as it has done for many decades.”
QuotedData’s Carthew adds that retail investors are an increasingly important part of the investor base for many investment companies.
“They dominate the share registers of many older funds. As long as ongoing charges ratios are reasonable, they are much less bothered about liquidity and much more focused on long term investment performance.
“The real danger is that the industry dances to the tune of a few wealth managers who have themselves consolidated so much that they can no longer offer their customers the same breadth of investment opportunities.”
Cost disclosure
Hawksmoor CIO Ben Conway, however, argues that while liquidity is a problem for smaller trusts, the current cost disclosure regime impedes the attraction of the sector as a whole.
Conway suggests that smaller trusts are becoming “increasingly irrelevant” due to consolidation among wealth managers, which has caused the minimum liquidity needs of wealth managers and multi-asset funds increase as a result.
“The bigger, fewer, larger wealth management firms you have, the higher that minimum liquidity threshold has to be. If you’re running ever increasing amounts of money due to consolidation within wealth management, and you’ve got a centralised investment proposition, then if you’re going to have something on your buy list it needs to satisfy minimum liquidity thresholds.
“A small investment trust isn’t going to cut it as that minimum size is getting higher all the time. If you’re running a daily-dealing fund like we do, we need to ensure that everything we invest in has daily liquidity to the position size that we own. A sub-£200m market cap trust is just not going to be liquid enough or big enough.
“Consolidation from that angle is absolutely necessary, because consolidation creates bigger vehicles. Larger vehicles means increased liquidity and therefore increased relevancy, opening yourself up to more potential buyers.”
On cost disclosure, he adds: “The current cost disclosure regime is creating a fall in demand, and just having a bigger vehicle isn’t going to suddenly increase demand enough to offset that, so really what we need to do is decrease supply as well.
“If you decrease supply relative to demand the discount should narrow, with all other things being equal. Consolidation activity isn’t really helpful unless you see a diminishment of the supply of investment company shares. Ideally, what you would see is a cash exit offered, but that’s very difficult to do in real assets and physical assets.”
