AIC sector shake-up: Perks and pitfalls for trust investors

The Association of Investment Companies’ sector changes to help investors compare ‘apples with apples’ have both pros and cons.

The investment trust sector has seen a sea change in recent years. Once a sideline, alternatives have entered the mainstream with new launches focusing on areas such as debt, infrastructure and unlisted equities.

Even within equity strategies, fund managers have sought to use the full powers of investment trusts to venture increasingly into smaller, less liquid areas. As a result of all this, the Association of Investment Companies (AIC) has re-jigged its sector classifications with the aim of better reflecting the modernised investment trust universe.

Major overhaul

The new system represents a major overhaul. A total of 13 new sectors were added, with 15 others renamed. Debt and property trusts saw a complete shift, with major changes also made to the Asia and ‘growth capital’ sectors.

At the time, Ian Sayers, chief executive of the AIC, said the changes should ensure that investment company sectors accurately reflect the shape of the industry.

He said:

“Recent years have seen significant growth in investment companies investing in alternative assets, such as property, debt and infrastructure, and the emergence of new asset classes such as leasing and royalties. Our new sectors allow investors to find and compare companies with similar characteristics easily.”

Certainly, a number of sectors needed a re-think. Many alternatives trusts were clumsily lumped together, meaning a comparison was tough. However, there have been grumbles that with just two or three funds in a number of sectors, the classifications are too granular and may not help with proper comparisons. This argument has some merit. Just under a third of sectors, 19 of the 63 categories, now have just one or two trusts. Only 18 sectors have more than eight trusts.

The sector review has been a year in the making and came into effect at the end of May 2019. The shake-up was launched in consultation with market makers, analysts and data providers. Annabel Brodie-Smith, communications director at the AIC, says the thinking was clear: the amount of money invested by investment companies in alternative assets has grown by 92% over the past five years, rising from £39.5 billion in 2014 to £75.9 billion in 2019. This is around 45% of the mainstream investment trust market. It needed to be better reflected in the sector classifications.

She recognises that some of the sectors are small and says the ideal would be to have at least two or three trusts in each sector. However, she argues the investment trust sectors can “grow” into the categories, with more alternative trusts launched each year. Property, for example, is fast-growing, evidenced by the fact that almost half of the property trusts with AIC membership were launched within the last five years.

Debt sector split

One of the major changes was to the debt sector, which has been separated into three new sectors: debt – direct lending; debt – loans & bonds, and debt – structured finance. This was urgently needed, as assets in debt funds have grown 493% in 10 years and now represent £9.1 billion in total assets across 31 companies. The new sectors still have 10, 13 and 8 trusts respectively.

The new classifications split out two riskier and more specialist sectors, Direct Lending and Structured Finance, from debt – loans and bonds, where managers are investing in more conventional fixed income instruments. Yields and discounts tend to be higher in the first two categories. Rather than being too granular, this seems like a necessary change to accommodate a growing sector.

Separating ‘growth capital’ from private equity may look a little pedantic, but there is an important difference between the two. Growth capital invests in unquoted shares, but doesn’t take major or controlling ownership stakes, as would happen with private equity. This brings different risks.

It was a major growth area, with Woodford Patient Capital the biggest ever UK investment trust IPO on its launch in 2015, while Baillie Gifford’s Schiehallion (LSE:MNTN) raised £364 million in March of this year. There is a danger that the problems at Woodford Patient Capital may hold back demand for this type of investment in the near term, but either way the sector looks set to grow over the longer term.

In contrast, the property sector reclassification has left some of the new sectors looking a little thin. Companies in the property direct – UK and property specialist sectors have been reclassified as property – UK commercial, property – UK healthcare, property – UK residential, and property – debt. The property healthcare sector houses just two trusts, Impact Healthcare (LSE:IHR) and Target Healthcare (LSE:THRL), while property securities has just one trust – the TR Property (LSE:TRY).

If those sectors are too small, analyst Kepler Partners has argued that, if anything, the newly expanded property – UK commercial sector is too large. It believes retail trusts, including The Local Shopping REIT (LSE:LSR), Supermarket Income REIT (LSE:SUPR), and possibly Ediston Property (LSE:EPIC), should be in their own sector, as should logistics trusts (Warehouse REIT (LSE:WHR), Urban Logistics REIT (LSE:SHED), Tritax Big Box (LSE:BBOX)).

Perhaps some of the more surprising changes have come among the equity funds. The new Asia classifications split the sector into large cap generalist trusts, trusts investing in Asian smaller companies and those focusing on income. Then there are the ‘country specialist – Asian’ trusts, which invest in one or two individual countries, mostly India and Vietnam.

Europe doubts

For Asia, this works. However, whether it also works for Europe is more questionable. The country specialist – Europe sector has just one fund (JP Morgan Russian Securities) and the European Emerging Markets sector (Baring Emerging Europe) also looks thin. This may fulfil Sayers’ ambition for investors to be able to “find” companies, but it does not help them compare.

This is a challenge for the AIC. Nick Greenwood, manager of the Miton Global Opportunities (LSE:MIGO), says:

“The sector classifications are, to some extent, a legacy from the days when the sector was more equity-focused. There are a number of new launches, such as royalties, where it’s very difficult to classify them.”

According to Adrian Lowcock, head of personal investing at Willis Owen, the revamped AIC sectors do make it easier to compare “apples with apples” and are therefore quite useful for investors looking for specific funds and strategies who perhaps want to compare an idea with the relevant peer group. But, he adds, the downside is that following the changes the increase in “the number of sectors available can mean the choice can be overwhelming for inexperienced investors”.

However, he believes this may be an inevitable consequence of trying to classify a disparate sector with a lot of idiosyncratic trusts. “This is partly a reflection of the one of the advantages of investment trusts,” he says. “Their closed-ended nature makes them suitable for a broad range of illiquid investment strategies. While it is good to see the AIC is reviewing its sectors to constantly improve them, it feels like investors could benefit from two tiers of sectors, allowing for a range of expertise and the ability to compare trusts that have similar objectives but perhaps invest in different asset classes.”

There are areas where sector classifications don’t appear to help much, but this is an inevitable consequence of the disparate investment trust sector, rather than any failing on the part of the AIC. As it stands, there are sectors that look likely to grow, so their current small size may not be a problem. However, others may continue to wither.

New AIC sectors

Renamed AIC sectors

Source: AIC

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