What’s behind more investment trusts joining forces?

The investment trust industry has in the past faced criticism for having too many small, sub-standard trusts with assets worth £100 million or less.

This has been changing over the past couple of years, with boards increasingly ringing the changes. Boards have the ability to replace an underperforming fund manager or fund management group, changing the trust’s strategy to broaden its appeal, or to close down the trust altogether.

Another option for small-sized trusts is to merge with a rival to create a bigger pool of assets to avoid continuing to fly under the radar. So far in 2024 investment trust mergers have hit a record yearly high, with six completed and another in the pipeline. This surpasses the previous record of five mergers, which was set in 2021 and 2022.  

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The biggest merger year-to-date has been between UK Commercial Property REIT and Tritax Big Box REIT (LSE:BBOX), which created a combined company with total assets of £5 billion. The five other investment trusts that have obtained the assets of a rival are Henderson High Income (LSE:HHI), JPMorgan UK Small Cap Growth & Income (LSE:JUGI), Fidelity China Special Situations (LSE:FCSS), JPMorgan Global Growth & Income (LSE:JGGI), and STS Global Income & Growth Trust (LSE:STS).

In addition, a merger between Henderson EuroTrust (LSE:HNE) and Henderson European Focus Trust (LSE:HEFT) is expected to complete in July.  

While, past criticism has been aimed at boards being reluctant to be ‘turkeys voting for Christmas’ in voting themselves out of a job, the uptick in mergers shows that boards are becoming more proactive.

Another sign of increased activity from boards is that 2023 saw the highest number of fund manager changes, nine in total, which was the most in a calendar year since 2009. Those manager changes included Mid Wynd International (LSE:MWY) appointing Lazard Asset Management following the retirement of its manager Simon Edelsten.

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Richard Stone, Chief Executive of the Association of Investment Companies (AIC), notes: “A record year for mergers shows that investment trust boards are responding to investors’ preference for larger, more liquid trusts that are easier to trade and cheaper to run. The median investment trust has more than doubled in size from £175 million of total assets ten years ago to £374 million today, excluding VCTs.”

Boards have also become more proactive in tackling wide discounts, which occur when an investment trust’s share price is trading below the value of its underlying investments, the net asset value (NAV). Data from Winterflood, the broker, shows that 118 investment trusts repurchased shares in April, the highest monthly number since records began in 1996. In total, the Association of Investment Companies (AIC) represents 350 investment trusts.

For James Carthew, head of investment companies at QuotedData, the key reason why investment trust boards have increased activity is due to wide discounts.

Carthew explains: “If wide discounts weren’t an issue, there would be far less activity. However, boards are casting around for ways to address the issue and they are regularly being told by the large wealth managers and by some brokers that small trusts fall below the radar and they need to consolidate to survive.

“I have always been in favour of mergers, and offering a rollover option into another trust, for funds that are struggling to justify their existence. My view has been that given the vast expense of raising fresh money from investors, it is better to keep it within the sector if at all possible.”

Simon Elliott, client director, JP Morgan Asset Management, agrees that boards are becoming aware of the importance of size.

“Boards have become more mindful of size in order to attract wealth managers and to benefit retail investors, as size leads to tighter spreads and lower costs.

“In addition, boards are more mindful on share buybacks in order to manage discount volatility.”

The average discount across 288 investment trusts that publish NAVs was -17.7% at the end of May, compared to -5% across 241 trusts five years ago, according to an analysis by IpsoFacto Investor.

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One of the attractions of an investment trust is the opportunity to pick up a bargain. But care needs to be taken, as discounts can widen further rather than narrow, which negatively impacts returns. Some trusts, particularly those that hold only a small value of assets, persistently trade on a wide discount of 10%-plus due to a lack of investor demand for the shares.

To boost demand for a trust’s shares and in turn improve its liquidity, boards have a few options: they can issue or buy back their own shares to reduce the discount, or alternatively remove discount risk entirely by putting what is known as a “discount control mechanism” in place. Those trusts with a discount control mechanism commit to keeping the discount within a certain range, typically anywhere from a zero discount to -10%.