What's behind the boardroom barney at Pollen Street investment trust?

I’m frequently asked why I am so enthusiastic about investment trusts as opposed to unit trusts or exchange-traded funds (ETFs). I hold all three types of fund, but investment trusts are my favourite. Their discounts to net asset value (NAV) and lower fees are key, but one reason stands out above all: independent boards of non-executive directors, who are paid to look out for investors’ best interests as opposed to the fund manager’s.

Most of the time these non-execs, or NEDs (I am a NED on a number of boards) work very hard to ensure investors get a fair deal. That might mean ditching an underperforming manager, running a fund down if it is no longer profitable or just having a frank discussion about fees.

A broken relationship

Unfortunately, sometimes, for all sorts of reasons, the relationship between the fund manager and the board breaks down. This would seem to be the case at a lending fund called Pollen Street Secured Lending (LSE: PSSL). An early pioneer in the online lending sector, it used to be known as P2PGI.

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Earlier this year the board received an offer for the fund’s loans from a company called Waterfall Asset Management. At 900p a share the bid was well in excess of the share price at the time, a vindication for many observers – including me, on this page – who thought the share price was too low. And the offer appears to have had extensive support from shareholders, including Invesco, the largest with about a quarter of the stock.

But then the fun and games started. In any bidding process there is usually an extensive disclosure of data, usually through a so-called data room, where hundreds, or even thousands, of documents are posted. An acquirer thus embarks on a comprehensive appraisal of the target company, a process known as “due diligence”. The target often has to post confidential documents relating to third parties. But in this case an almighty battle has emerged over disclosure, which has resulted in the board giving the fund manager, Pollen Street Capital, a 12-month termination notice.

The board believes that Pollen Street Capital is trying to ensure that this bid will not proceed. It says the manager is “playing games with the due-diligence materials and painting a misleading picture of how matters are proceeding. The bottom line is that we want to investigate this potential offer with Waterfall but after the best part of two months we currently cannot give them any meaningful due-diligence materials”.

Pollen Street Capital insists it has acted in good faith and has placed more than 2,000 requested documents in a secure data room for over four months. But the board says “the documents are heavily redacted; a significant number are historic and/or irrelevant … the data room is of no meaningful use whatsoever”.

Crucially Pollen Street Capital points to confidentiality clauses relating to some of the lending information that has resulted in several external platforms – almost certainly lenders – saying they do not want to have their confidential information shared with Waterfall. Note, too, that the fund paid the manager £13.9m in the year to 31 December 2018, so the loss of the contract is likely to be very painful for Pollen Street Capital.

The verdict

The upshot? The board seems to have done the job most of us would have expected of it, not least its largest shareholder. Pollen Street Capital may have valid concerns but ultimately investment trusts are not the property of the fund manager – they are owned by the likes of you and me. It is the investors’ money and, frankly, if someone is willing to make a generous offer that should be the end of the debate, especially given the inauspicious post-Covid-19 outlook.

If we look at the big banks, we can see that most are increasing their bad debt provisions four- to six-fold. According to fund analysts at Jefferies, annualised impairments (bad debts) at PSSL were – pre Covid – running at roughly 1.5% to 2%.

If the fund were to follow in the footsteps of the banks, that number could increase to 7.5%, implying big losses. As I understand it, Waterfall has delayed its possible offer; if it falls away the fund will probably go into run-off.

But assuming the NAV is still around the 950p mark, a big increase in loan provisions could see 50p a share wiped off that number, in turn implying that any future offer might come in well below the earlier 900p. In that case, not taking up that earlier offer starts to look a tad foolhardy, to put it mildly.