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James Carthew: imponderable questions in quest for scale

James Carthew: imponderable questions in quest for scale

Last week I addressed the uphill battle Ashoka India Equity (AIE) faces if it wants to expand, having raised just £46.5 million in its flotation. It is by no means the smallest fund out there, however.

Many of the very smallest funds are in wind-up mode, with just a handful of assets they are in the process of selling. Nevertheless, setting these aside, I reckon that there are still about 38 funds with a smaller market value than Ashoka. These range from Chelverton Growth Trust (CGW) with a market capitalisation of just £3 million and Aberdeen Frontier Markets (AFMC) at £47 million.

The main issues faced by small trusts are illiquidity, wide bid-offer spreads, high ongoing charge ratios and budget constraints when it comes to finding ways to attract new investors.

Illiquidity does put off most large wealth managers. Nick Greenwood, manager of Miton Global Opportunities (MIGO), made that point in his recent manager’s report. ‘The sheer size of funds now managed by a small number of houses makes it difficult for investment trusts to figure within these portfolios.’

Rathbones failed to buy Smith & Williamson but it is hoovering up Speirs & Jeffrey, which has big holdings in trusts such as Murray International (MYI), Temple Bar (TMPL), Murray Income (MUT), Aberdeen Asian Income (AAIF) and JPMorgan Global Growth and Income (JPGI). Will these be put up for sale? Fortunately, there are some large wealth managers which do not centralise investment decision making and these may still have room for trusts in their portfolios.

For most individual investors, illiquidity is not usually a problem; most of their trades will not move the dial. Spreads – the gap between the buying and selling prices of trusts – are a real issue, however. There is a 12% ‘spread’ on Chelverton Growth and it is by no means alone. I count 82 investment companies, including venture capital trusts (VCTs) and some small share classes, trading on spreads of 5% or more.

The trouble is it is hard to come up with a solution to that problem because there is a strong inverse correlation between spreads and size. For example, the spread on £2.3 billion Tritax Big Box (BBOX) real estate investment trust is just 0.065% and on £7.7 billion Scottish Mortgage (SMT) is just 0.18%.

Clearly the best solution to this problem is growth and – trite as it sounds – delivering good returns is still the easiest way to achieve that. It takes a lot of small investors to have a meaningful impact and, no matter how much commentators like me try to encourage investors to see the potential value in the unloved and out of fashion, individual investors tend to favour the funds topping the performance tables.

Miton Global Opportunities is actually a good example of this. It sits near the top of the leader board in the AIC Flexible Investment sector over three and five years. The fall in the pound after the Brexit vote in 2016 provided a welcome fillip for its portfolio given its globally diversified portfolio. Underlying holdings such as Taliesin Property and India Capital Growth (IGC) began to motor around the same time. It also introduced a new three-yearly realisation opportunity (providing liquidity for investors that want to sell) and stepped up its marketing activity. The combination of these factors led to a gradual narrowing of its discount and, finally, share issuance.

Some trusts do well in NAV performance terms but still struggle to trade at premiums long enough to issue shares. The go-to mechanism for growing such funds in the past has been to issue subscription shares, warrants or convertibles. I know that such issues divide opinion. Some investors love the ability to get geared exposure to a trust, some hate the potential NAV dilution and the added complexity.

These issues can work though. India Capital Growth’s one-for-two subscription share issue was crucial in it surpassing the £100 million mark. It came at the potential cost, however, of investors looking at its ordinary share NAV performance and thinking it wasn’t keeping pace with its benchmark (because of the dilution effect). This is why I always try to quote the returns on its portfolio rather than its ordinary share NAV.

Another trust that used this route as a way to grow was Atlantis Japan Growth (AJG). It embedded subscription rights into its ordinary shares for a while. Every October, shareholders had the right to buy one share for every five they held at a price equivalent to the NAV a year earlier. This process was helped enormously by the decent performance generated by Taeko Setaishi after she took on responsibility for the trust from Ed Merner in 2016.

However, what happens if the subscription shares are in the money but a large slug of shareholders do not wish to commit more capital? Usually, a trustee is appointed who sells the subscription share rights on their behalf. This runs the risk of widening the discount at which the shares stand below NAV.

It might be coincidental but the discount on Standard Life UK Smaller Companies (SLS) has widened since its 3.5% convertible loan stock was converted in April. Fortunately, its discount is still within reasonable bounds but another trust in a similar situation might feel obliged to buy back stock, negating the size boost that the subscription share or convertible had provided.

Funds need to ensure there is demand for the new ordinary shares they are creating. This comes back down to marketing; a bit of a chicken-and-egg problem if you weren’t big enough to have a marketing budget in the first place.

James Carthew is a director at Marten & Co, operator of the QuotedData website. The views expressed in this article are his and do not constitute investment advice.


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