Investment trusts and the “Brexit dividend”

Investment trusts tend to focus on domestic investors

Last week we talked to one City insider about how Brexit is affecting her company. We’re going to continue this theme by talking to another person who has a close professional interest in keeping abreast of how things are going: Ian Sayers of the Association of Investment Companies. The AIC represents closed-end investment trusts that are quoted on the stock exchange. This also includes offshore companies and venture capital trusts. According to data on its website, this covers over 250 companies with total assets of more than £84bn.

Sayers cautioned us that investment trusts are in a rather unique position compared to the rest of the financial sector. Most of the City gets a large amount of its revenue from selling financial services to the rest of the world. In contrast, investment trusts are very focused on domestic investors, with an estimated 95% of the money in the sector coming from inside the UK. As a result, most trusts don’t do much cross-border marketing to the rest of Europe. In turn, this means that the immediate effect of Brexit has been felt indirectly through asset markets.

Sayers admits that, so far, things “have been much more positive” than he expected. While the fall in the pound may prove to be a problem for other parts of the economy (such as retailers), it has helped those funds that invest aboard, because the sterling value of those overseas assets has increased. Mark Carney’s decision to cut interest rates last August has also boosted the returns of fixed income funds (there is an inverse relationship between bond prices and interest rates, so lower rates mean higher bond prices).

He also thinks that the domestic focus of the investment trust industry means that one of the possible “Brexit dividends” will be the chance to “shape regulation in our own interest”. The main problem is that “the context of the UK investment industry is different from that of the rest of the EU”. As a result, “European regulators are not so familiar with our needs and ways of doing things”. This difference means that the resulting directives from Brussels are “not as sympathetically drafted” as they could possibly be, compared to those from the UK.

One piece of European legislation that has proved to be particularly controversial is the Packaged Retail and Insurance-based Investment Products (PRIIPs) directive. This legislation aims to standardise the information that investment vehicles are allowed to give to investors. However, Brussels originally proposed rules that would make it much harder for funds to disclose past performance, replacing this with an estimate of potential future returns under various scenarios. The Association of Investment Companies (AIC) believes that past performance should be included, though it accepts that “this should be over a longer period”. At the moment, a range of products are at risk of being caught by this regulation.

Because of disagreement within Brussels the wording of the regulation has been delayed, with implementation now not expected until 2018. Sayers expects a final decision to come particularly soon, possibly within as the next three months. In his view, “there is little point spending the nine months redrafting, leaving only three months to prepare for the implementation”. Having had “lots of contact” with the government, he’s confident that “the message is getting across”, leading to some sort of compromise, benefiting both the industry and the investor.

Another example of where doing things on an EU-wide level doesn’t work as well as it should is the Prospectus Directive. This means that all funds, whatever their size, need to provide a lot of detailed information in their prospectus, some of which is “quite complicated”. This is “bad news” for smaller funds because they still have to spend “hundreds of thousands of pounds” on lawyers. Since the AIC has had “little success” in lobbying Brussels to adopt a more flexible attitude, this may be a case “where UK specific regulation could help”.

Of course while “tailored regulation” could cut the costs of doing business in many areas, Sayers is cautious that “we shouldn’t overestimate the costs of EU membership”. Indeed, even if we have a hard exit “we’re not going to throw out the entire EU rulebook”. Indeed, “in some cases the AIC’s own code actually goes further than EU law”. He also notes that the AIC represents the investment trusts, not the firms that run them (which are separate in many cases). These investment management companies may have their own perspective on Brexit.