We highlight the trends and themes for investment trust fans to keep an eye on over the next year.
At the start of a year it is always challenging to predict investment performance for different investment trust sectors or asset classes in the months ahead. But it is less difficult to identify the key trends that have shaped the closed-ended fund industry itself over the past year, and those likely to prevail in 2021.
One of the most significant themes of 2020 has been the run of manager changes, closures and consolidations in the industry. In itself, it is unsurprising, as Annabel Brodie-Smith, communications director at the Association of Investment Companies (AIC), observes: “There is normally quite a lot of this sort of change when markets are tough.”
But more broadly, Ewan Lovett-Turner, investment company research director at Numis, makes the point that there is increasing pressure on trusts to become bigger and more liquid in order to be of interest to large wealth managers and retail platforms (such as interactive investor) catering for private investors. Yet around 45% (by number) of the closed-ended universe of around 400 companies are trusts worth less than £200 million.
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“Some trusts follow mini-strategies because they want to stay relatively small – those that invest in very small businesses, for example – but those that are undifferentiated from their peers and limited in scale need a strategy for growth or improvement if they are to survive,” says Lovett-Turner.
Some boards have simply wound up in the face of that pressure: AIC data shows 20 companies have been closed this year, out of a universe of around 400.
Other struggling equity-focused trusts have sought new managers. High-profile examples include Witan Pacific’s move to Baillie Gifford, changing its name to become Baillie Gifford China Growth (LSE:BGCG), as well as enjoying a huge re-rating in the process, Temple Bar (LSE:TMPL)’s move to RWC Asset Management, and most recently Keystone also proposing to join the Baillie Gifford stable under its Positive Change team.
But the most significant move towards growth has been through mergers. These are rarities in the closed-ended fund world, but a couple took place in 2020, the big one being Murray Income’s consolidation with Perpetual Income & Growth to create a trust worth almost £1 billion.
“Many boards have been looking at their strategy, and this is bolder than a change in manager or mandate. I would expect to see more mergers, especially in the £200 million to £400 million range, in 2021,” predicts Lovett-Turner.
Businesses worldwide have been impacted by the pandemic and many have had to cut or suspend dividend payments to shareholders. That has had a knock-on effect on equity income funds’ ability to make payments, but closed-ended funds have been much more strongly placed than their open-ended peers.
That is a reflection of their ability to hold back up to 15% of dividends received each year, to build up a rainy-day reserve. This year, those reserve funds have proved very valuable for many income-paying trusts facing dividend cuts, says Brodie-Smith.
According to the AIC, four trusts (three of them in the UK equity income sector, plus a global equity income trust) have cut their dividends in 2020. In addition, Edinburgh Investment (LSE:EDIN) and Troy Income & Growth (LSE:TIGT) have announced that they will cut their 2021 dividends.
A number of the so-called dividend hero trusts with longstanding records of year-on-year dividend growth (or at least no dividend cuts) have been at pains to protect their payouts and track records. “Temple Bar dropped off the dividend hero list, as did British & American (LSE:BAF), but the rest have held up,” comments Brodie-Smith.
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Moreover, some non-equity areas have proved extremely resilient in terms of reliable income, including infrastructure, logistics and specialist debt.
But there remains a question mark over the state of equity dividends in 2021, says Simon Elliott, director of investment company research at Winterflood. “Will equity investment trusts be able to keep growing their dividends next year? Prospects are reasonable; the use of their dividend reserves buys them time, so even if dividends in 2021 aren’t back up to 2019 levels, they should be able to get through to 2022.”
Against that, Lovett-Turner suggests, there is a debate about the right level of income to pay out relative to that being generated. “How far should you use reserves or capital to maintain or grow your dividends, and does that position change if 2020’s experience is more than a short-term shock?” he asks.
“Are we seeing a fundamental rebasing of equity yields? I think many will be very reluctant to keep paying out of reserves if so. It is a big question, particularly as 2021 rolls in and we see the full-year impact of cuts in portfolio income.”
IPOs and new issuance
It has been relatively quiet 12 months in terms of secondary fundraising, down around 25% on 2019, with most funds flowing into alternatives rather than equities. The few areas where activity has increased this year compared with 2019, which are not a surprise given the global circumstances, are trusts that focus on: technology and media, biotechnology, and environmental.
IPOs, meanwhile, were practically non-existent until autumn. But an upturn in risk appetite since October, together with new opportunities and pent-up demand, has turned that dearth around to some extent.
According to AIC data, a further five trusts have launched or announced they would launch by the end of 2020, including Triple Point Energy Efficiency Infrastructure, social housing-focused Home REIT (LSE:HOME) and Downing Renewables & Infrastructure (LSE:DORE).
James Carthew, head of investment trust research at Quoted Data, makes the point that the bulk of both secondary issuance and IPOs has been “on the back of the green agenda”. He adds: “They have generally been income plays as well, with yields of 5% to 7% and progressive dividend policies common.”
In contrast, equity fund launches continue to struggle - particularly if there is a danger they will slip immediately to a discount, as is almost inevitable with UK trusts at the moment.
Although there were three such trusts trying to raise money in the autumn, two gave up and only Schroder British Opportunities (LSE:SBO) has launched, raising just £75 million (it had targeted £250 million) to invest in listed and unlisted UK equities. “It will take a while for this part of the market to pick up, especially as there are already plenty of decent UK funds around,” says Carthew.
Demand for sustainable investment
As we’ve already seen, social and environmental themes have prevailed as far as fundraising is concerned in 2020. “There has been a massive trend towards more socially aware launches and demand for trusts doing the right thing,” says Elliott.
He considers Schroder BSC (Big Society Capital) Impact to be a notable recent launch (it is sponsored by Winterflood, as he points out). It will invest in a mix of social housing, charity bonds and other holdings designed to deliver a positive social impact. It listed towards the end of last month.
“Having heard what the team has to say, I do think it has a very different type of ethos,” he comments. “I think more socially responsible investments will follow, too.”
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Elliott also expects to see a shift towards greater transparency across the investment world, including existing investment trust boards. He gives the example of Alliance Trust (LSE:ATST), which now discloses the carbon emissions of its portfolio holdings because it believes shareholders have an interest in that information.
Lovett-Turner agrees, pointing to the small-cap Odyssean (LSE:OIT) trust, which has recently formalised its enhanced ESG due diligence and engaged approach in managing its portfolio. “Disclosure needs to improve a lot – it is pretty murky at the moment, but I expect boards and management teams to focus more on it in future,” he says.
Other continuing trends for 2021
The downward pressure on fees that has been seen over the past few years is expected to continue. “Around 45 companies have amended their charges to help consumers in 2020, and that’s likely to continue next year,” says Brodie-Smith.
More managers are following Baillie Gifford in looking at stakes in late-stage private equity, says Elliott. “Companies are staying private for longer, and fund managers are aware that if they wait until flotation they risk missing out on much of the best growth. Investment trusts’ closed-ended structure makes them a good vehicle for that.”
Finally, Carthew suggests more trust boards are likely to implement the option for equity income funds to use capital as income, as a fallback if dividend reserves run low.
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