I was on a panel at an investment trust conference last month. Most of the questions were pretty straightforward. The last one wasn’t.
A member of the audience asked us if we thought that investment trusts should be cheaper than other types of investment fund.
The other panellists didn’t see a reason for investment trusts to be cheaper. They just thought generally that all products should offer value one way or another. I think there is rather more to it than that.
Let’s look briefly at the key difference between an investment trust and a unit trust. The former are listed companies, the business of which is to make money out of investing in other companies and the purpose of which is to make as great a total return as possible for its shareholders.
The latter are mostly one of a suite of products run by a company, the business of which is to make money out of selling units in funds to other people.
Now think about company directors. Their main responsibility is to maximise shareholder value.
For the directors of investment trusts, that means creating the maximum possible return from their investments at the lowest cost possible. For the directors of the companies running unit trusts, it is to make the most possible money from those funds, and that, in effect, means gathering more assets.
The former have a duty to get management fees down. The latter, although they do technically have boards too, effectively have an incentive to keep them up.
So should investment trust management fees be, on average, lower than other fund management fees? If their boards are doing their jobs properly, the answer has to be yes, they should.
The fact that investment trusts are run by boards of directors in the interests of their shareholders is the main thing that attracts me to them for my own Isa and Sipp. It is also why I worry when there is a suggestion that boards might not be doing the right thing by their shareholders.
Right now I am worried about Alliance Trust, one of the UK’s oldest investment trusts. It was established back in the late 1800s in part to provide a home for the vast sums Dundee’s merchants had made selling jute for sandbags to both sides in the US civil war.
Dundee isn’t making much money out of jute (or much else) at the moment, but it is getting to play a leading public role in another battle involving aggressive Americans.
That’s because Alliance now has as its largest shareholder a part of US hedge fund group Elliott. And Elliott isn’t happy with the board at Alliance Trust, saying:
• it has been displaying mediocre (at best) performance for too long;
• that its costs are far too high;
• that it wastes money on its two lossmaking subsidiaries;
• that its chief executive, Katherine Garrett-Cox, is too overpaid (over £1.35m in 2013) to have any incentive to change things;
• that the board (which has lost more directors in the first three years of their tenure than the other 12 biggest trusts combined over the past seven years) is too weak and useless to make her;
• and that all this is reflected in the shares’ whopping 12% discount to net asset value.
They’re also cross that despite being the trust’s biggest shareholder, no one ever tells them anything.
Yes, I’m paraphrasing, but they’re particularly irked that in September, Alliance dumped its previous head of equities and changed its investing strategy without consulting them.
Elliott isn’t taking all this lying down.
It wants three new independent board members, who they paid a head hunter to find. They want the new directors to force a few discussions about how investing Alliance’s money should be outsourced to a group who can do a better job; how costs can be cut; and how the subsidiaries should be sold.
Alliance says all Elliott’s accusations are nonsense (I’m paraphrasing again) and that the would-be directors are a Trojan horse planning to force a massive share buyback that will close the discount and allow Elliott to ride off into the sunset at the expense of all the other shareholders.
Elliott is right enough on most of its points. Alliance does need shaking up and its big new wheeze — investing in line with socially responsible values — is a bit silly. From my conversation with the head of equities, it seems no more than a complicated way of implementing the good practice of normal long-term investing.
I am told (but can’t verify) that back in the 1980s, fund managers at Alliance had to write a letter of explanation to the chairman if they bought and then sold a stock within a year. I bet that worked at least as well.
Alliance isn’t entirely wrong with its rebuttals.
It’s perfectly true that Elliott isn’t likely to be a long-term investor. I asked them last week how far the discount would have to close before they sold up. They said they had no particular number in mind. I bet they do.
But still, a strong and focused board acting in the interests of all its shareholders would have dealt long ago with all the problems Elliott are flagging, particularly as this is hardly the first time Alliance has been targeted by activist investors.
They would have made sure that Alliance was a cheap, well-run, moderately performing and yielding fund suitable for pretty much everyone all the time, something I was almost convinced would happen after my last trip to Dundee in 2011.
If they had, the discount would be a couple of percentage points, and no one would ever have heard of Elliott.
In a video they have been promoting on Twitter (@Alliance_Trust), the trust notes that “we understand that the future doesn’t just happen, it is driven by the power of investment.” That’s clearly true. Just not quite in the way that its board might have imagined.
All this will come to a head at Alliance’s annual meeting on 29 April. I can pretty much guarantee there are going to be fireworks, and if Elliott gets what it wants, I might even then suggest you buy the trust. Shareholder capitalism: it’s exciting stuff.
• This article was first published in the Financial Times.