Investors are urging trusts to change their practices in order to remain popular with clients
Analysts continue to call for larger and more liquid funds across the investment company sector as scrutiny of managers and boards is expected to increase through 2021.
Brokers have long called for a shake-up of the investment company sector, with Numis analyst Ewan Lovett-Turner lamenting in July there were too many sub-scale companies trading on wide discounts and called on them to wind up or merge with existing companies.
“The consolidation of wealth managers, the Woodford scandal and MiFID II have increased the focus on liquidity and costs, meaning that a large portion of the investment company universe is not investible to many of the core buyers,” Lovett-Turner explained.
The analyst predicted M&A would “remain disappointingly difficult to achieve”, but thought the tide may turn as “key stakeholders become more engaged”.
Indeed, Lovett-Turner noted a “clear-up” of sub-scale funds had begun post-Covid, with a number of boards recommending shareholders vote against continuation, alongside the UK equity income mega-merger between Murray Income (MUT) and Perpetual Income Growth (PLI), which created a near-£1bn sector behemoth.
“We believe there is scope for the sector to undergo a period of consolidation, emerging with fewer investment companies, but offering a more relevant proposition to investors,” Lovett-Turner reasoned.
How did they get here?
As wealth managers’ assets under management grow, the minimum size of fund in which they can invest that cash does, too.
Today, many will not look at funds below £400m in size, according to David Harris, partner at Frostrow Capital.
This presents a problem for the sector, as almost two-thirds (206 out of 345) of investment companies, ex VCTs, have net assets of less than £400m, according to Association of Investment Companies (AIC) data.
More than a third (128) have net assets of less than £200m. Just 11, or 3%, have in excess of £1bn.
If the largest buyers of investment companies will not touch these smaller funds, it impedes their ability to grow and could leave many languishing on wide discounts with no clear catalyst for a re-rating, Harris said.
As well as pressure from the wealth manager community, head of investment trusts at Fidelity International Alex Denny questioned the economic viability of such small trusts.
“If you are an investment management house and you are running things at less than £150m, I cannot believe that you actually make any money,” he questioned.
“In which case, how do you display your commitment to running that business?”
Some smaller merger activity has taken place over the past few years, most recently the rollover of Invesco Perpetual Growth into the Invesco Perpetual Select Trust’s UK Equity portfolio. However, the combined trust will still have a market capitalisation of less than £200m.
Harris said more mergers need to happen between unconnected trusts, though caveated that aggressive takeovers tend to be less successful and can “waste a lot of time, effort and money”.
MUT’s tie-up with PLI is a good example of a successful merger between unconnected trusts, with the transaction giving shareholders a vehicle with greater scale, better liquidity and lower fees.
Denny suspects we would have seen more M&A activity had the Covid-19 market downturn lasted longer: “The fast market recovery might give people a period of respite where they decided they do not need to do anything. I actually think it would be better for the sector overall if the consolidation continued.”
Peter Walls, manager of the Unicorn Mastertrust fund, said the MUT deal was “groundbreaking” and “welcome”, but noted the circumstances were “peculiar” and doubted a similar move would occur elsewhere in the sector.
Ben Mackie, fund manager at Hawksmoor Investment Management, acknowledged there was an issue with sub-scale investment trusts and said that against a changing industry backdrop, “there is certainly a need for trusts to stay relevant”.