The recent boardroom bust-up at the UK’s biggest mainstream investment trust, Scottish Mortgage, may have made for an unedifying spectacle, but it has shone a light on the role of independent governance in closed-end funds – often touted as a key benefit of the structure when compared with open-ended investments.
Broadly speaking, the role of an investment trust board is to represent the interests of the shareholders. The directors – all of them ideally non-executive and independent of the fund manager, although there are a few exceptions – should be responsible for setting the company’s purpose and strategy, hiring and firing investment managers, and other decisions such as gearing and dividend policies.
While it is not the board’s job to make investment decisions, the directors should understand how the investment strategy is being delivered, and be able to provide constructive – and if necessary robust – challenge to the fund manager. This arguably increases in importance with the complexity of the investment approach.
Part of the argument publicly advanced last month by Professor Amar Bhidé – now an ex-director of Scottish Mortgage – was that the trust’s board lacked the necessary skills and experience to oversee the large allocation to unlisted companies. “Scottish Mortgage raised the limit on such investments from 25% to 30% in 2022, and after sharp falls in the value of its listed holdings over the past year, the allocation stood at 29.9% at end-February (the latest available factsheet), limiting the managers’ ability to supply any additional capital required by the trust’s existing unlisted holdings and effectively putting a brake on any new investments.
While this may be a technical issue – listed companies can be immediately valued based on their share price, while unlisted holdings are valued less frequently, and therefore could be ‘worth’ less than their current weighting in the portfolio – it does underscore the desirability of specific board expertise in a trust that has a huge and long-standing retail investor base who may be unaware of how the portfolio has evolved over time.
When Home Reit – a property trust set up with the laudable aim of providing quality accommodation to the homeless and vulnerable – ran into trouble in late 2022, the board – two former property company CFOs, a radio journalist and former government special adviser, and an investment manager – drew criticism for failing to spot significant accounting issues, alleged property overvaluations and conflicts of interest between the fund manager and property developers, leading to calls for the chair, Lynne Fennah, and the audit committee chair, Marlene Wood, to resign. The company’s shares are currently suspended and all the board members remain in place as they seek to resolve the audit issues and find a new investment manager for the fund.
While all UK companies with a premium London Stock Exchange listing are technically required to comply with the Financial Reporting Council’s 2018 UK Corporate Governance Code on board independence, composition and responsibilities, the Association of Investment Companies has its own 2019 version, the AIC Code of Corporate Governance, which is endorsed by the FRC in recognition of the different nature of externally managed investment companies versus operating companies.
Provisions in the AIC code include that boards should consider both share price and NAV performance, monitor share price discounts or premiums to NAV and act appropriately to manage them, and keep an eye on risks and costs as well as the implementation of the investment strategy. Boards are required to “have a combination of skills, experience and knowledge”, and both appointments and succession plans “should be based on merit and objective criteria and, within this context, should promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths”.
While the FRC code prohibits a company chair from remaining in post for more than nine years (with limited exceptions, such as where the chair was already a non-executive director), the AIC takes a more flexible approach. However, investment company boards themselves increasingly see a nine-year limit as being best practice not just for the chair but for all the directors.
This was another plank in Professor Bhidé’s argument, and has led to the announcement that Scottish Mortgage chair Fiona McBain (14 years on the board) and director Paola Subacchi (nine years’ tenure) would stand down at the trust’s AGM in June. Yet solving one perceived problem could give rise to another, as the pair are the only two women on the five (previously six)-strong board, meaning the trust will potentially no longer comply with the voluntary target of 40% of women on FTSE 350 company boards unless the best candidates identified for the vacancies are female.
In terms of diversity of skills, Ms McBain trained as a chartered accountant (as did two of the remaining directors) and Ms Subacchi is an economist; the other remaining director is a professor of medicine. While having three chartered accountants (albeit within a range of professional settings) on the board should perhaps have gone some way to allaying Professor Bhidé’s concerns on the directors’ ability to oversee the exposure to unlisted companies, it arguably struggles to meet the aims of ‘a combination of skills, experience and knowledge’ and ‘diversity of … cognitive and personal strengths’. However, Scottish Mortgage says succession planning with a view to further board refreshment has been ongoing over recent months, and “that process is now well advanced”.
High-profile problems aside, the fact remains that the presence of an independent board is generally a force for good, with many investment trust boards in recent years having pushed down costs for investors, sought to merge, liquidate or find new management for sub-scale or sub-par strategies, and introduced value-enhancing measures such as redemption opportunities and discount control mechanisms. The fact that the recent bust-ups have played out in public perhaps only serves to underline the benefit of having an open and accountable governance structure.