Faith Glasgow examines the role of investment trust boards, explaining how they are a force for good, while also pointing out some criticisms.
The recent widely publicised spat between members of Scottish Mortgage (LSE:SMT)’s board of directors has once again focused attention on investment trust boards as a unique aspect of the closed-ended fund structure.
But what is the role of boards – and do they do a better job better these days, from the point of view of the shareholders whose interests they are supposed to represent?
Investment trusts are required to have independently elected boards of directors because they are structured as companies listed on the stock exchange. The directors act as an interface between investors’ interests and the fund management company.
The role of boards for investment trusts
They are not involved in day-to-day decisions or performance – that’s the job of the fund manager – but they can make important calls about the way the trust is run.
If the manager is chronically underperforming against peers, for example, it’s the board’s job to decide whether it is time to sack that manager and find another, or at least put them on notice.
The board is also responsible for setting the fee structure (for instance, whether to employ performance-related fees) and negotiation of fees with the manager.
It decides how the trust’s share price discounts and premiums to the value of the underlying assets should be managed, and establishes its dividend policy (for instance, whether to supplement income received by the trust with capital to maintain a set dividend payout).
So the board can potentially make a big difference to outcomes for shareholders; they may not always like those outcomes, but they can make their preferences known by asking questions and voting at the board’s annual general meeting.
Past board criticism
In practice, however, there has historically been criticism of investment trust boards on a number of fronts, not least the fact that many were heavily ‘male, pale and stale’, often had no personal stake in the trust as motivation to require good performance, and took a pretty passive approach to governance generally.
There is broad consensus that things have improved markedly over recent years - driven, among other factors, by the raised profile of investment trusts as greater numbers of retail investors have accessed them through online platforms, more direct competition with open-ended funds, and wider drives to improve diversity on company boards.
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As James Carthew, head of investment companies at QuotedData, observes: “Generally, the standard of boards and their interactions with shareholders are much improved over the past decade.”
Carthew picks out improvements in communications with shareholders as an example. “I was always concerned that retail investors who could not attend an AGM were not getting the same access to management teams as institutional investors,” he explains.
“However, in learning to live with Covid, many investment companies now hold regular webinars that many more investors are able to participate in. Capital markets days, at which investors get to hear from the management of underlying companies, are also more prevalent than they were.”
Boards have become more pro-active
For Peter Hewitt, manager of the Columbia Threadneedle Global Managed Portfolio Trust, which invests solely in other investment trusts, the improved make-up of boards has helped to make them more proactive, particularly as more women directors have become involved.
He points to the board of the boutique Odyssean Investment Trust (LSE:OIT) (on which he himself sits, independently of his role managing CMPI) as “a board that works just tickety-boo. It’s demanding, holds the manager to account, but supportive.”
There has also been diversification in terms of professional backgrounds and skill sets of board members. Carthew suggests that ideally, boards should include “someone with a finance background, perhaps someone with a marketing/communications background, perhaps someone with a legal/corporate finance/compliance background and someone with experience of whatever the fund is investing in”.
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More broadly, adds Hewitt, board appointments these days involve headhunters, shortlists and rigorous interviews, rather than ‘jobs for the boys’ or candidates suggested by the fund management company (who would find it hard to take an impartial stance on issues such as fee reductions or performance management).
“It’s quite professionally done now, which doesn’t guarantee that the board operates well, but it certainly helps,” he says.
Other areas in which boards have made positive moves include the reduction of fees on many trusts and widespread scrapping of performance-related fees. Some 27 trusts made fee changes beneficial to their investors in 2022.
Andrew McHattie, publisher of the Investment Trust Newsletter, comments: “In a competitive environment there is plenty of scrutiny on those who are charging more than their peers.”
There has also been an increased focus on dividends and reliable year-on-year dividend growth, spurred on by investors’ desperate hunt for income in the face of rock-bottom interest rates and given further impetus by the success of the AIC’s Dividend Hero campaign.
Are boards doing enough to control discounts?
Nonetheless, while governance is improving and boards are becoming more proactive and more answerable to investors’ interests in many respects, not everything is rosy.
One particularly contentious issue is the question of whether or to what extent the boards of equity-based trusts should actively manage the extent of their discounts.
Peter Spiller, longstanding manager of Capital Gearing (LSE:CGT), has much to say on the matter as an area where many boards are failing in their obligations to shareholders.
He points out that discounts became effectively ‘voluntary’ in 1999 when the investment trust rules changed to allow trusts to buy back their own stock, “so it's disappointing that so many discounts are still around 24 years later”.
Since then, a lot of trusts have introduced schemes to manage their discounts, in many cases adopting some kind of discount control mechanism (DCM).
The idea is that the board targets a certain level upper level of discount, typically 5%; when the discount exceeds that threshold, the board starts buying back its own shares to reduce supply and thereby bring in the discount. More recently some, including Capital Gearing, have gone further, adopting a zero discount mechanism (ZDM).
However, says Spiller: “A number have not fulfilled their promise; they have generally bought back some shares, but not with enough vigour to bring the discount in to the threshold.”
He points to trusts such as abrdn Asian Income Fund (LSE:AAIF) (buyback target discount -5%), Allianz Technology (LSE:ATT) (-7%) and Polar Capital Global Financials (LSE:PCFT) (-5%), all of which are currently (as at 3 May) sitting on double-digit discounts despite the DCMs in place, while BlackRock Income and Growth (LSE:BRIG) professes a ZDM but trades at a -10% discount.
Spiller acknowledges that buying back shares can have implications for trusts: the fact that there are fewer shares in circulation means they are smaller, less liquid and costs per share rise. But, he argues: “All these outcomes were true when the boards made these promises in the first place. They just didn’t think it through properly.”
He is especially disparaging of the boards that have actually removed their previous controls, including Henderson European Focus Trust (LSE:HEFT), which did away with its 3.5% DCM trigger and now sits on a -11.5% discount, and BlackRock Throgmorton Trust (LSE:THRG), where the board removed the 2% discount target and six-monthly buybacks.
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Peter Hewitt takes a similar, albeit slightly less hard, line on discount management, arguing that if investments trust issue shares, then as a basic principle they should also be willing to buy in shares if need be.
“My view is that share buybacks can influence the discount, but there’s a whole series of other factors also at work. F&C Investment Trust (LSE:FCIT), for example, had a hard DCM of 10% until 2017, so the discount resided for years between 9.5% and 11% – but it was buying in shares all the time.” F&C’s board now aims to keep the shares trading close to NAV; it currently trades on a 5.2% discount.
Carthew, however, says that many investment trusts have recently done better in terms of discount control. He adds: “Active discount control policies don’t work for all funds – the underlying portfolio needs to be fairly liquid as a minimum. It is entirely reasonable to suspend these in periods of extreme market volatility.”
He suggests that boards are walking a tightrope between having a long-term pool of capital and all the benefits that brings, and protecting shareholders from the impact of volatile and overly wide discounts. “The ability to preserve capital and use it to pick up bargains from panicky sellers is one of the great benefits of the structure,” he adds.
Overall, as Spiller readily acknowledges, “boards are realising that they need to do something, and the zeitgeist is improving all the time. I don’t think there are any boards meeting and not discussing how to address the discount issue, though some are finding excuses not to take action. But changing a whole culture always takes time.”
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