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In markets, there’s often an argument that more means better — as it leads to greater variety and choice.
But with 380 investment trusts in existence has this popular investment sector gone too far, with too many small fish swimming around the pond? Is it perhaps time for a cull — for a slimmer, more streamlined and more efficient industry?
Aside from the general point that smaller trusts often have higher costs, critics say they face a specific challenge with the consolidation of the wealth management industry.
Peter Spiller, the veteran manager of Capital Gearing Trust, a chunky trust worth £1.2bn, argues that this is a serious problem for scores of smaller trusts worth £400mn and less.
The difficulty is that wealth management firms are obliged by the Financial Conduct Authority to channel all their clients with a particular risk profile into the same investment portfolio. Continuing consolidation within the wealth management industry means the dominant firms are increasingly driven to use only trusts big enough to accommodate substantial positions.
The percentage of wealth firms willing to invest in sub-£100mn trusts had fallen from 70 per cent in 2013 to just over 30 per cent in 2023, according to Winterflood’s 2023 industry survey.
“If you’re [a big wealth firm such as] Rathbone, say, with £60bn under management, you just can’t buy an investment trust where only £100,000 of stock is available at a time,” says Spiller. “The result is, broadly, that trusts with assets of less than £400mn-£500mn have become unviable.”
Mick Gilligan, head of managed portfolio services at Killik & Co, concurs. “A lot of the really big wealth managers are unable to add a trust to the buy list unless they are comfortable that their advisers can buy across the board without pushing the price up.”
That assessment leaves a large tranche of investment trusts effectively out of consideration for larger wealth firms. The Association of Investment Companies’ tally of almost 380 listed investment trusts, with a combined market value of more than £200bn, is dominated by about 50 trusts with market values above £1bn, of which five — including Scottish Mortgage, F&C and Greencoat UK Wind — top £3bn. But more than 270 have a market cap of less than £500mn, with 99 worth less than £100mn.
Spiller argues that many small trusts — even well-run ones — are stuck on “permadiscounts” to the underlying value of the portfolio, with poor liquidity (it’s not always easy to buy or sell shares in them) and wide spreads that make them expensive.
However, this is not the end of the story. AIC data shows that the very largest trusts, worth £2bn-plus, trade at a modest discount, below 7 per cent. But for the rest, the sub-£100mn trusts are little different from larger rivals, with a weighted average discount of 14.25 per cent, compared with 12.5 per cent in the £100mn-£250mn bracket and 15.2 per cent for the £250mn-£500mn range.
One route for trusts perceived as redundant has been consolidation with a comparable peer, to achieve scale and efficiency. Annabel Brodie-Smith, the AIC’s communications director, says: “We have seen a wave of consolidation within the investment company sector in recent years . . . and this year the pace has stepped up.”
The past two years have seen 10 investment company mergers completed, and another deal has been proposed this year, says Brodie-Smith. Additionally, since 2021, 12 boards have decided to liquidate their company and return money to shareholders. Two companies this year have agreed offers for their assets and around a dozen have announced plans to wind up or have implemented strategic reviews.
As Spiller’s co-manager Chris Clothier observes, there are some obvious candidates for corporate action. He picks out Abrdn Japan, a small, poorly performing large companies trust, which is being rolled into the top-performing Nippon Active Value, run by Rising Sun Management.
Similar trusts run by the same management house are also prime targets for consolidation, BlackRock Throgmorton and BlackRock Smaller Companies being good examples.
However, other industry observers disagree. While they accept that small trusts with mediocre records should go, they still see a valid role for smaller trusts, given the growing importance of retail investors on shareholder registers. Data from the AIC and stockbroker Argus Vickers shows retail investors hold 51 per cent of trust stock and fully 67 per cent of equity trust stock.
As James Budden, director of marketing at Baillie Gifford, observes: “Many smaller trusts are largely owned by the clients of Hargreaves Lansdown, Interactive Investor, AJ Bell and other platforms.”
Similarly for Andrew McHattie, publisher of the Investment Trust Newsletter, wealth managers, although important, “are not the only buyers in town” and should not be calling all the shots. “Eliminating smaller trusts will inevitably restrict choice for private investors, and deter newcomers,” he warns.
It’s not just about maintaining investor choice. The investment trust industry has historically been keen to embrace new ideas, as the renewable energy sector demonstrates — and that typically means starting small and growing. For example, Gresham House Energy Storage listed in late 2018 at £100mn is now seeking an additional £80mn to take its assets over £900mn.
When it comes to investing in smaller companies in particular, there is a clear argument in favour of smaller trusts. As McHattie explains: “For managers seeking to invest in illiquid markets — in microcap (sub £100mn market cap) UK shares, for example — it is impossible to take meaningful stakes with a large pool of capital.” He cites River & Mercantile Micro-Cap as an example of a smaller trust that can invest in such stocks.
But investment trust directors don’t take account only of shareholders’ interests. They would not be human if they didn’t think also of their own jobs — jobs that are lost when a trust is wound up or merged. As Spiller wryly observes, directors’ self-interest “possibly doesn’t help”.
For Spiller, however, there is a magic bullet. He argues that an alternative to consolidation is adopting a zero discount policy (ZDP). This involves the trust buying back or issuing stock as needed, to keep a check on excess supply and demand and thereby control the discount or premium.
One example in the UK equity income sector — which is home to 13 sub-£500mn trusts — is Troy Income & Growth. As Gilligan points out: “Although its market cap is only £184mn, it has a ZDP and so punches above its weight in liquidity provision.”
ZDPs attract controversy, because they involve investment trust boards being prepared to shrink the size of a trust to control the discount, and they are not currently widely used.
However, Spiller speaks from experience: Capital Gearing itself had a market cap of only £400mn or so at the start of 2020, but a ZDP policy plus good investment performance and low volatility during a turbulent period have enabled it to grow to around £1.2bn now.
Perhaps the answer is that there is still room for small trusts — but they will have to work harder to justify their existence.
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