Investment trust analysts have welcomed a stock swap that sees the Woodford Patient Capital Trust take on unlisted companies from the Equity Income fund in exchange for trust shares.
Woodford Investment Management announced on Friday it would shift £73m of unquoted stocks from its Equity Income fund into the Patient Capital Trust in exchange for new shares at net asset value. Following the transfer, the UK Equity Income fund will own 9% of WPCT and WPCT will account for 1.45% of the income fund.
The new shares will be admitted to trading on 6 March.
Paper loss for Woodford Equity Income
“On the face of it, this appears to be a transaction that is more beneficial for [Woodford Equity Income] than WPCT,” said Stifel analysts Iain Scouller and Anthony Stern in a research note published on Tuesday morning. However, the note pointed out the closed-ended fund shares were trading at a 13% discount at the time of the transaction therefore resulting in an immediate £9.5m paper loss for Equity Income investors.
Stifel has maintained its positive view on the Patient Capital Trust, which it upgraded from a hold to buy in late November. The trust’s exposure to the five companies (Atom Bank, Carrick Therapeutics, Cell Medica, RateSetter and Spin Memory) had increased significantly from 7.2% to 14.1% providing the potential for uplift in value if the holdings perform well over time.
Woodford Patient Capital re-rating
Winterflood, which likewise published an analyst note ahead of new shares going live tomorrow, expected the support of the Equity Income fund could lead to a re-rating of the closed-ended fund’s shares. Analysts Kieran Drake and Simon Elliott highlighted that the holding could grow from its current 9% while the open-ended fund could take advantage of the trust’s discount via the secondary market.
The Equity Income fund could hold up to 20% of the trust under Ucits rules.
Drake and Elliott described the move as positive for shareholders, although the pair also thought it was beneficial for Equity Income fund investors. “The open-ended fund has a reasonable exposure to the same early stage businesses that appear in the investment trust’s portfolio, but the former is limited by the level of unquoted investments that it can hold due to liquidity that it has to provide,” the note said.
Transaction highlights benefits of investment trust boards
On Friday, immediately after Woodford revealed the changes, JP Morgan said the swap highlighted the benefits of independent boards of directors on investment trusts.
Analysts Christopher Brown and Adam Kelly said: “This shines a light on the differing governance standards that exist for closed and open ended funds in our view. Closed-end funds have an independent Board of directors whose job it is to safeguard the interests of shareholders. Open-ended funds have no such protection and we would be surprised if the open-ended fund investors would be happy with the dilution they will face on their WPCT investment.”
Despite this, JP Morgan lists the Patient Capital Trust as an underweight.
Willis Owen head of personal investing Adrian Lowcock last week told Portfolio Adviser it didn’t make sense for equity income investors to hold 10% in patient capital. The Patient Capital Trust does not pay a dividend and Stifel highlighted that it currently has a revenue account deficit of £3.4m.
Woodford Investment Management chief executive Craig Newman last week said the objectives of the fund remained firmly intact. “The Woodford Equity Income Fund has always aimed to deliver a growing income stream and a total return by investing predominantly in listed stocks, with some exposure to unquoted holdings to generate excess returns from disruptive technologies.”
Woodford could have undue influence over trust
However, Stifel raised concerns about Woodford Equity Income becoming a major shareholder noting there are few other large institutional holders of the trust. “We would hope in the case of any votes that have an impact on the management group or its financials, that the [Woodford Equity Income] stake in WPCT is subject to an abstention mechanism,” the analyst note stated.
While the transaction would increase the trust size 10%, Stifel noted the trading liquidity was unlikely to improve if the Equity Income fund is a long-term holder.
Woodford would not respond to Stifel’s concerns when questioned by Portfolio Adviser.
