Investment trust boards have been accused of inertia when it comes to consolidation even after 2021 produced a record five deals worth £708m.
This month, shareholders in beleaguered UK Mortgages discovered the underperforming strategy was set to merge with Twentyfour Income Fund, run by the same manager, creating a cheaper and more liquid vehicle.
That means £2.2bn worth of mergers are already pencilled for 2022, thanks to the merger of JP Morgan Growth and Income and Scottish Investment Trusts due to complete by the end of Q1. In the last decade, there have been no more than two mergers in any given year and there was zero activity between 2014 and 2016.
Association of Investment Companies communications director Annabel Brodie-Smith notes there were as many mergers in 2021 as the previous five years combined. “This is because boards are becoming increasingly proactive as they respond to investor demand for larger, more liquid investment companies that can deliver the benefit of economies of scale to shareholders and potentially better performance.”
Too many sub-scale investment trusts trading at discounts
But Jefferies says the pace of consolidation in the investment trust sector remains too slow.
Already this year, the Strategic Equity Capital board has poured cold water on a potential £350m tie up with Odyssean, which runs a similar UK small-cap strategy.
“With so many sub-scale issues trading at discounts while the buy side demands ‘fewer but larger’ it seems counter intuitive that the industry should be so inefficient at recycling capital,” Jefferies said in an analyst note this month.
The note continued: “Surely it can’t be beyond the wit of imaginative deal makers to find more opportunities like that in a universe of some 350 companies?
“In a sector that is forever asking investors for more cash for new issues, recycling ‘dead’ capital from obsolete mandates lacking the scale to qualify for buy lists must be a win/win for all stakeholders.”
The number of professional investors willing to buy investment trusts smaller than £150m is shrinking, according to Winterflood. In 2013, 93% of respondents to its annual investment trust survey said they were prepared to invest in strategies this size, a statement which now only applies to 63%.
In contrast, 23% now need investment trusts to be £200m in market cap to invest, compared to just 3% in 2013. Out of a universe that includes 336 investment trusts, excluding VCTs, 106 have a market cap less than £200m, according to AIC data.
We should focus on smaller investors
But not everyone agrees bigger is better.
QuotedData head of investment companies James Carthew says: “However much the big private client brokers may bleat about needing larger more liquid trusts, the reality is that they have become too large and unwieldy to invest in the sector, and we should wave them goodbye to focus more on the needs of smaller and retail investors.
“Size for size’s sake risks cutting managers off from the types of exciting but less liquid opportunities that can help drive superior performance and are ideally suited to closed-end structures.”
Sometimes consolidation is needed though, he says.
“When an investment company is struggling and investors have lost faith – often as evidenced by a persistent wide discount – we much prefer to see a merger with another more successful fund in the sector rather than liquidation or open-ending, although this should be accompanied by some form of cash exit opportunity.”
Which investment trust mergers have gone well?
The merger of Mark Barnett’s former Perpetual Income and Growth with Murray Income in December 2020 is one that Carthew applauds.
But he is less keen on the Abrdn China strategy that was created from a merger of Aberdeen Emerging and Aberdeen New Thai.
“Aberdeen Emerging was a good fund, with an improving track record but an overly concentrated share register,” he says. “The new fund is holding up well relative to peers but seems to have started life with a discount problem which will need to be addressed.”
Overall, Carthew thinks the pace of consolidation is about right.
“A bit more might get done if the paperwork was simpler and the advisory fees lower, but investors in investment companies are much better off than those in the open-ended market where fewer checks and balances, for example the absence of an independent board, means that failing funds can languish for much longer.”