2nd May 2025
During the summer of 2023 we wrote a series of Crescendo blogs highlighting the issues facing the investment trust sector and offered some suggestions on how these might be resolved. This was written during, what felt at the time, a rather depressing outlook for the sector as discounts had widened to historically wide levels. We believed discounts were at risk of becoming entrenched unless drastic action was taken by all stakeholders, but we sensed a worryingly relaxed attitude among many participants who believed the problem was more cyclical than structural. Hence the desire to communicate our thoughts at the time. Almost two years on, the investment trust sector trades on roughly the same discount despite a much broader acceptance of the issues and a marked increase in corporate activity. We therefore thought a revisit of the various issues raised in the ‘We Need To Talk About Investment Trust’ series might be timely.
Discounts remain wide
The sector today trades on an average of c.18% compared to c.20% in 2023. Obviously, an average figure can be misleading and should not be relied upon for a representation of value. Indeed, you should never cross a river based on its average depth. However, we know from looking across the investment trust sector that many sub-sectors remain at the same level or even wider than 2 years ago. Those are mostly amongst ‘alternatives’ like infrastructure, shipping, renewable energy and private equity where discounts remain wide despite numerous positive developments across all those asset classes. We covered the reasons for wide discounts in our note and these reasons remain pertinent today (higher interest rates, opaque NAVs, penal cost disclosure guidance and a shrinking community of buyers etc), but we are two years further down the line and there are encouraging signs of improvement.
Cost disclosure update
We won’t go into the numerous inconsistencies of the FCA Cost Disclosure guidance again, but the impact has made certain investment trusts appear suddenly more expensive and prohibitive to own for many. A long campaign which has involved participants inside and outside the trust sector, including Members of Parliament and Lords and Baronesses and the Hawksmoor Fund Management team, has culminated in a consultation paper that was submitted to the FCA in March this year. The support has been overwhelmingly positive so we are optimistic for a return to a world where all retail and institutional investors can report the expenses of investment trust investments accurately as we did for over a century before 2018. Specifically, costs should be disclosed as expenses that are deducted from the NAV – not ongoing charges that are deducted from the share price. In that environment, we expect a number of buyers that have since exited the sector to return given the numerous well-known benefits the closed-ended structure of an investment trust provides.
Supply demand better but still not in equilibrium
Based on the deal flow we see from brokers, the selling pressure from wealth managers seems to be abating, but only very recently post tax year end. Although a short period, alternative trusts have behaved relatively well during the Trump Tariff Turmoil, with investors perhaps comforted by the certainty of high yields and transparent underlying cash flows versus the new uncertainty of global equity markets. M&A is now a reality rather than a dream two years ago and is removing some trusts from the sector. Cash bids for trusts including Atrato Onsite Energy, BBGI and Care REIT should see money reinvested back into other discounted peers. There are further cash bids in progress for the likes of Harmony, Assura and Warehouse REIT, and there are likely to be more. This is always a double-edged sword as it is usually the better quality names that get taken out first and there has been a distinct lack of M&A in the renewables sector where question marks over the depth of buyers for operational assets persists. Quite a few conventional trusts have been consolidating with cash exits typically offered as part of a deal that will reduce the number of shares for the new combined entity. We have warned certain trusts that simply seeking a merger won’t necessarily result in a narrower discount. Of course, greater scale and liquidity are desired by everyone but simply merging two small 20% discounted trusts will probably result in one mid-sized trust on a 20% discount. Significant cash exits are a pre-requisite for mergers provided it doesn’t impair the scale required to attract a new constituency of buyer. Meanwhile, other trusts have simply accepted the inconvenient truth that they are sub-scale or haven’t lived up to expectations and are winding up and returning cash to investors – Miton Microcap and Keystone Positive Change count among those. We expect a further reduction in the number of trusts over the course of 2025. Our last Crescendo referred to our Global Opportunities Fund having 20% of assets in 15 trusts on a weighted average discount of 34% that are likely to disappear or be restructured within 12 months.
On the other side of the supply/demand equation, efforts to attract new buyers is at best a work in progress. There are only a couple of examples of trusts recently switching to an operating company and incorporating earnings data in order to attract generalist equity investors. It is too early to judge whether the switch by Supermarket Income to an internal management or Taylor Maritime to a commercial company structure has brought equity investors to the register, but all boards will be watching carefully. All boards and managers should be targeting pension funds and promoting the merits of the investment trust structure versus semi-liquid vehicles like LTAFs. The feedback we hear is that the sector is too illiquid for the large institutions who are prepared to accept the limitations of LTAFs in return for supposedly unlimited, albeit periodic, liquidity.
Improved corporate governance
Scepticism that the sector will shrink itself remains – ‘turkeys don’t vote for Christmas’ after all! However, from our engagement with various trusts it is clear that the majority of boards, managers and brokers have woken up to the new reality that the status quo is unsustainable. It is hard to say whether the improvement is proactive or prompted by the arrival of activist shareholders in the sector, first Saba and more recently Achilles Investment Company. Regardless, it is positive for all stakeholders. Under more stringent capital allocation policies there has been a record amount of capital returned to shareholders via buybacks, tenders, special dividends and redemption facilities. In addition, we’ve seen numerous strategic reviews announced and a handful of measures to address the obvious conflict of an external management contract, including all or some fees tied to market cap, and a couple of internalisations. Shareholder engagement has definitely improved as demonstrated by the opposition to Urban Logistics’ internalisation plan and The Renewable Infrastructure Group’s new management fees which were both quickly reversed in reaction to shareholder feedback. Despite good intentions, some alternative trusts have struggled to implement their new capital allocation policies owing to the illiquid nature of the underlying assets. This is particularly true of private equity trusts such as Harbourvest and Pantheon who won plaudits for their rigid discount linked policies but where the poor exit environment has acted as an impediment given the required portfolio liquidity relies on realisations. Share buybacks have been lower than expected as a result and discounts have remained wide. That said, most of the infrastructure trusts and both the shipping trusts have been able to sell assets at or close to carrying value to validate their NAVs and release cash for buybacks or debt repayment. Of course, share buybacks are more of an accretive capital allocation decision rather than a silver bullet to fix wide discounts, but aggressive buybacks and tenders alongside other measures will ultimately contribute towards narrower discounts. Overseeing asset sales, strategic reviews, new capital allocation policies and shareholder engagement is a time-consuming business and we’d be advocates of directors of alternative trusts earning more with a view to attracting the required talent and expertise.
Two years on – better but still scope for improvement
In summary, there has been significant progress to address discounts across the sector, most notably within the alternative space. There are numerous examples of boards and managers doing the right thing by shareholders – a marked shift in behaviour from two years ago. A willingness to shrink first to then be able to grow later is now consensus whilst the theme of better aligned management fee structures is gaining momentum. M&A is real and we hear that brokers’ corporate finance departments are busy working on various consolidation or takeover deals – after all there isn’t an active IPO market so they have to be doing something! Actions taken by peers and the presence of activist investors in the sector force all boards and managers to be proactive in their ambition to narrow their own discount. Solving the supply side of the equation is something the boards can control much easier than finding new buyers. That said, we can see a very rosy future where US equities no longer outperform and money is rotated into UK equities and investors see the benefit of active management or alternative assets within an investment trust wrapper that is rightly deemed to be zero cost. An environment where more buyers are coming into a shrinking sector will create very attractive shareholder returns. From a dark place two years ago, we are incredibly optimistic that the light at the end of the tunnel is firmly in view, although there remains plenty of work to get there.
Daniel Lockyer – Senior Fund Manager
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. FPC25383
