Merian last week announced it would be shifting the bulk of the unquoted companies in its small and mid-cap funds to its closed-ended Chrysalis investment trust, which it is funding through a £100m share placing.
In an apparent reference to the Woodford Equity Income fund suspension, it said “recent events have resulted in a heightened level of interest regarding this type of investment in open-ended funds”.
In April, Woodford swapped £73m of unquoted stocks into his Woodford Patient Capital trust in exchange for a 9% stake in the closed-ended fund as questions mounted about the true level of his exposure to illiquid assets.
Woodford Investment Management has said that when the fund re-opens for its slated Christmas release the bulk of its holdings will be in undervalued FTSE 100 and FTSE 250 names.
Unlike Woodford, Merian’s open-ended funds would not take a stake in the Chrysalis trust as part of the transfer.
‘This is where the regulator should be getting involved’
SCM Direct co-founder Gina Miller (pictured) has called for unquoted stocks to be purged from daily dealing funds due to an “inherent liquidity mismatch”. “Were the FCA to be a competent regulator, it would enforce such a rule with a 12-month deadline to allow open ended funds to sell or transfer their existing unquoted holdings,” she tells Portfolio Adviser.
But Miller does not think transferring unquoteds from an open to closed-ended structure is the answer.
“There are significant conflicts of interest in transferring such assets ‘in-house’ which would be best avoided in all but truly exceptional circumstances,” she tells Portfolio Adviser.
Fund Expert managing director Brian Dennehy notes that Woodford’s decision to swap out holdings in five unquoted investments for a 9% stake in the underperforming Patient Capital Trust raised similar concerns over potential conflicts of interest.
“It doesn’t feel right,” he says of shifting assets between vehicles. “This is where the regulators should be getting involved.”
Portfolio Adviser understands the authorised corporate director (ACD) is responsible for managing the fund in the best interest of investors and as part of this would need to ensure the best execution rules are followed and any conflicts are identified and managed.
The depositary would also need to be satisfied that the deal was appropriate.
‘Knee jerk reaction’
Dennehy says these transfers are a particularly raw deal for the investors in the investment trust who have little say on the illiquid assets coming into the fund.
“They didn’t buy the investment trust thinking it might become a dumping ground for unquoteds which, presumably, cannot be sold at anything like the price which was being presumed by the unit trust/Oeic fund administrators,” says Dennehy.
Dynamic Planner head of asset and risk modelling Abhimanyu Chatterjee says the current stock transfers seem like “a very big knee-jerk reaction”. “Because Woodford has gotten into a problem everybody’s worried and everybody’s shifting out.
“I think that’s the problem with our industry. You have something and it goes out of fashion and everybody has a knee-jerk reaction because there’s so much adverse political and adverse media views on it. Nobody wants to get caught in that.”
Investment case has to stack up
Winterflood Investment Trusts head of research Simon Elliott says valuations are the biggest issue when it comes to transfers.
“In the case of moving unquoteds from one vehicle to the other clearly there’s a question over valuation. If you’re moving quoted, securities from one to the other that’s less of an issue because you have a publicly available quote, but in the case of unquoted companies, that’s been more difficult to do.”
Elliott says in the case of meaningful transactions, like Woodford’s and Merian’s, the board would have a hand in assessing valuations and making sure there were third-party valuations being carried out.
The investment objective and strategy of the open-ended fund and the investment trust must be taken into consideration, he says.
“It can’t just be a case of this works for the fund manager in question. The investment case clearly has to stack up.”
Such moves would also need to be approved by the trust’s board, Elliott says.
“Investment trusts are not the property of the fund management group. So though in many cases they have their branding, whether it be a JP Morgan fund or Janus Henderson or whatever, investment trusts have independent boards”.
Merian touts benefit to Chrysalis investors
A Merian spokesperson pointed out that Merian Chrysalis already invests in all of the unquoted companies held in the small and mid-cap funds.
They reiterated that the acquisition of additional shares from the open-ended funds, which were purchased at “a modest discount” to the latest valuations, was a positive for Chrysalis investors “as they will benefit from a well-balanced portfolio, as well as the continuation of a sufficient level of full investment”. They added the transaction is expected to be accretive to the trust’s net asset value.
“Since launch, Merian Chrysalis has traded at a premium to net asset value reflecting the strong demand for access to the portfolio and this part of the market,” the spokesperson continued.
“Further, as we continue to believe that the underlying companies represent a good investment opportunity, the open-ended funds currently holding Merian Chrysalis will participate in the placing. It is anticipated that the Merian Chrysalis shares will be issued at a premium to the latest available NAV, but a discount to the prevailing market price.”
Woodford Investment Management declined to comment.