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The Privilege of Permanent Capital

9th December 2022

You will know by now how passionate we in HFM are about investment trusts. I won’t list all the reasons why we think they are one of the greatest success stories of the UK’s financial services industry. In short, they give democratised access to some of the world’s best investment managers, as well as access to asset classes that would otherwise only be available to the world’s super-rich via private vehicles.

A key feature of the investment trust is the permanent nature of the capital. This allows the manager to invest in less liquid asset classes. Unlike an open-ended fund, the amount of capital cannot vary with anything other than the value of the assets. If performance is bad, shareholders cannot simply sell back their shares to the company – unlike open-ended funds where poor performance will ultimately lead to mass redemptions and leaving the manager with no capital to manage.

The manager of an investment trust enjoys an extremely privileged position: the virtual guarantee of a stream of revenue via ad valorem fees that are paid on a fixed pool of capital.

This is one of the reasons why the Board is so important. The Board is there to act in the best interests of shareholders – to make sure that their collective interests are expressed, and collective wishes carried out. If, for example, the managers deviate from the strategy they were employed to deliver, or execute that strategy poorly, the Board can act and replace them.

Unfortunately, all too often (in our view) Boards do not act in the shareholders’ best interests. Conflicts of interest can be very hard to avoid, and the Board itself faces one when shareholders demand a measure that undermines the future of the trust. Were a trust to wind up or shrink to an uneconomic size, the Board members would lose their jobs and the accompanying salaries. We watch for situations where the Board is too aligned in this regard with the manager. It is our job to constantly remind Board directors who they are employed by (the Company (or trust) not the investment manager) and who owns the Company (the shareholders).

The current situation with VPC Specialty Lending (‘VSL’), an investment trust in which our multi-asset funds hold a position, is in danger of highlighting some of these issues. We are very supportive of the efforts of our fellow shareholders Metage and Staude Capital in holding the Board to account and ensuring appropriately high levels of corporate governance. They are attempting to address the unsatisfactory level of the discount on the trust, as well as navigate the tricky issues of the largest investor in the trust being a connected party of the investment manager and the portfolio being a very eclectic mix of not very liquid investments. Their resolutions, which they are putting to a general meeting that they called this week, are sensible and address the concerns and interests of all shareholders.

Often institutional investors are accused of ignoring the plight of the many retail investors who invest via platforms and are not able to vote on these resolutions. Importantly in this case, the resolutions also address the concerns and interests of those investors, many of whom are retail and apparently less bothered about the level of the discount, who would like VSL to continue in its current form and keep delivering its income.

Good corporate governance is about listening to all stakeholders, and, where appropriate going with the majority of shareholders (whether that be 75% or 50% depending on the resolution). Better governance listens to the needs of the independent minority and delivers a healthy compromise for them too. The best governance also puts the wants of all these shareholders above those of the Directors and certainly the investment manager. The investment community is watching and opportunities like this should be seized upon by Boards as an opportunity to demonstrate to the world that the UK’s investment trust sector is home to the world’s best standards of governance.

Corporate governance is never going improve without these public confrontations. We should welcome those investors who are prepared to dig in for the long haul, engage with Boards and investment managers over a period of many years, and who are prepared to follow the difficult path of more public engagement and even activism. Harking back to our blog of 21st January (see here), all too often investors ignore the G in “ESG”. We should be thankful for the efforts of investors like Metage, Staude Capital and Asset Value Investors who attempt to uphold the very highest standards of governance and benefit shareholders not just of the trusts they are involved in, but of all investment trusts.

*the Hawksmoor Funds are shareholders

Ben Conway – Head of Fund Management

Ben Conway

For professional advisers only. This article is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. FPC724.

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