Eight months in, 2024 is already a record year for M&A (mergers and acquisitions) in the investment trust sector.

Trust boards are increasingly focused on value for money and shareholder returns amid persistently wide discounts to NAV (net asset value) and with activists nosing around. A major trend underway is mergers between sub-scale trusts with similar remits to create funds large and liquid enough to attract wealth managers and retail investors.

The investment trust sector faces some structural headwinds to demand which explain these stubbornly wide discounts. These include the rise of tracker funds, retail investors pulling in their horns due to cost of living pressures, not to mention the misleading cost disclosures casting a pall over sentiment towards closed-ended funds.

Due to this dicey backdrop, Deutsche Numis says trusts are ‘in a battle to stay relevant in the face of a lack of demand from many traditional buyers’ and with fixed income offering yields that offer a credible alternative to ‘alternatives’.

A consequence of smaller trusts combining with rivals or winding-up is that some good strategies will go to the wall in this process of creative destruction, but larger vehicles should be more liquid and reduce trading costs, and have scope to spend more on marketing, thereby gathering more assets and creating a virtuous cycle of growth.

This new landscape of investment trust giants has many positives, but there are also negatives for investors to be aware of.

THE URGE TO MERGE

The current spate of mergers is justified by calls for fewer, larger trusts from a dramatically consolidated wealth management sector, together with increased focus on costs. A merger can be a silver bullet for addressing a persistent discount, because combining two or more smaller trusts creates a single vehicle offering superior liquidity and economies of scale.

James Carthew, head of investment companies at QuotedData, says one justification for mergers is that the big wealth managers, who are themselves consolidating, ‘have to write such big tickets that they cannot contemplate investing in small funds for fear of dominating share registers.

‘That is a valid argument but the minimum size that they will accept has risen rapidly from a couple of hundred million a few years ago to a billion or more today.’

Cynics might reason that corporate advisers’ need to supplement their income in the absence of a lucrative IPO (initial public offering) market is another factor behind this urge to merge, while managers will be looking to add to their assets under management or find ways of preventing money from flowing out the door.

Running costs and bid-ask spreads are an issue for sub-scale trusts and both tend to increase as funds get smaller. In contrast, bigger investment trusts benefit from scale economies, appeal to a wider range of investors and can also negotiate better terms on debt to boot.

COME TOGETHER, RIGHT NOW

This year’s standout deals including the proposed mega-merger of Alliance Trust (ATST) and Witan (WTAN) to create a goliath called Alliance Witan with net assets north of £5 billion and a market cap big enough for FTSE 100 inclusion. This bigger investment trust beast will also carry lower ongoing charges with a target around the high 50s basis points in future, below Witan’s and Alliance Trust’s current ongoing charge ratios of 0.76% and 0.62% respectively.

2024 has also witnessed several mergers between trusts sharing the same management group, including JPM Multi-Asset Growth and Income into JPMorgan Global Growth & Income (JGGI), a trust whose assets have risen rapidly through strong performance and mergers, having previously absorbed stablemate JPMorgan Elect and also The Scottish Investment Trust.

The sector has also seen a combination of JPMorgan UK Smaller Companies and JPMorgan Mid Cap, two trusts which shared the same managers and had portfolio overlap aplenty, to create JPMorgan UK Small Cap Growth & Income (JUGI), not to mention the merger of two Janus Henderson Investors-managed Europe funds to form Henderson European Trust (HET).

On 2 September Artemis Alpha Trust (ATS) announced it had agreed to be taken over by UK All Companies sector rival Aurora Investment Trust (ARR).

Other examples include the rolling of the Troy Income & Growth into STS Global Income & Growth (STS) and abrdn China into Fidelity China Special Situations (FCSS), while RTW Biotech Opportunities (RTW) has also acquired Arix Biosciences.

SURVIVAL OF THE FITTEST

Deutsche Numis believes it is healthy that trusts that have failed to live up to expectations are reinvented, merged or wound-down. This should mean that the remaining universe of trusts ‘becomes more attractive to potential investors, as the strong survive’.

Peter Walls manages the Unicorn Mastertrust Fund (3121801), which aims to achieve long term capital growth by primarily investing in a range of listed investment companies. ‘If you look back over the last 50 years, 85% of the trusts that existed in 1974 do not exist today,’ he informs Shares. ‘And throughout those decades many new trusts will have come and gone as well. I consider this process of sorting the wheat from the chaff to be an important feature for investors as it ensures that when things do not go according to plan there can be a solution.’

Walls thinks the Alliance Witan merger is one that makes a lot of sense. ‘It will create a large liquid trust which will give index funds a run for their money. The merged trust will have plenty of tools in its toolbox, including share buybacks and issuance, to incrementally enhance total return for long-term investors,’ he enthuses.

Also weighing in is Thomas McMahon, head of investment companies research at Kepler Partners, who thinks the current wave of consolidation is to be celebrated.

‘There have been plenty of trusts on persistent discounts for years that just haven’t been wide enough to prick boards into doing something about it, and the shakeout of the past 18 months or so has forced action,’ says McMahon. ‘There will be time for a thousand flowers to bloom, but now is the moment to cull the ancien regime.’

McMahon highlights JPMorgan Global Growth & Income as an acquisitive trust that is giving investors what they want. Over the past two years or so, it has absorbed three trusts with very different approaches to investing globally that had struggled to get to scale.

‘The combination of a quality growth portfolio with an optional income is clearly highly appealing to a broad variety of investors, while the successful execution of the strategy, evident in strong performance numbers, has built confidence in the managers,’ explains McMahon. ‘Or take the absorption of UK Commercial Property’s assets by Tritax Big Box REIT (BBOX). Just as consumers want cheap Amazon deals, investors want to own the logistics network that makes them possible, and the market is giving them what they want.’

CASH ME OUT PLEASE

Charlotte Cuthbertson, co-manager of MIGO Opportunities Trust (MIGO), says that with discounts at historically wide levels, it is reassuring to see boards ‘not resting on their laurels and the fact that there has been lots of acquisitions, mergers, realisations etc. It is important for boards to be very thoughtful about their shareholders and do the best thing for them. Liquidity is important, especially in a world that is becoming ever more illiquid. However, it can be a bit of an easy way out, because what’s very important for all investors, whether it is retail or institutional when you are going through these merger processes, is for there to be a cash exit option.’

For the uninitiated, it is considered good practice for boards to offer shareholders the chance to redeem some or all of their shares for cash as part of a merger deal. Cuthbertson reasons: ‘Otherwise you end up with an overhang of shareholders that just want out and actually that doesn’t improve liquidity, because what you’ve now got is a big trust with an overhang. Cash exits are very, very important so that you can head off if you want to.’

BIG ISN’T NECESSARILY BEAUTIFUL

A major negative arising from this Darwinian process for the private investor is reduced choice. One thing keeping James Carthew awake at night is the degree to which investors are encouraging these deals ‘because they have been disappointed by short-term performance, and funds that might rally when the cycle turns will no longer exist.

‘This is most evident in the property sector, where the number of funds on offer is shrinking rapidly and just ahead of a likely rally in the sector as interest rates fall.’

Other areas of the market where this could also be the case include Japan, where following a bout of underperformance by small cap trusts, there has been a rush for the exit, most recently with the proposed absorption of JPMorgan Japan Small Cap Income & Growth (JSGI) by JPMorgan Japanese (JFJ). ‘One of the strengths of the investment companies industry is that a fund with a fixed pool of capital can take advantage of short-term swings in sentiment - acting as a buyer of last resort and therefore picking up bargains,’ Carthew informs Shares. ‘However, this wave of M&A is disrupting that.’

Unicorn’s Walls adds: ‘Big isn’t necessarily beautiful of course. There has to be a place for smaller investment trusts if the sector is to offer diversity and provide a launch pad for the successful trusts of the future. The trust sector would be a poorer place without the likes of Rockwood Strategic (RKW), Odyssean (OIT) and Strategic Equity Capital (SEC). Elsewhere, I need to be able to consider investing in smaller specialist trusts such as Literacy Capital (BOOK) or RTW Biotech Opportunities.’

Walls also makes the point there needs to be a place for bringing new strategies to the market to invest in less liquid specialist investments, ‘otherwise trusts that could emulate the success of AVI Japan Opportunity (AJOT) and Nippon Active Value Fund (NAVF) will never get off the ground’.

‹ Previous2024-09-05Next ›