This year is shaping up to be a landmark one for the investment trust sector. It entered 2024 in turmoil. Trusts were trading at the widest average discount to net asset value (NAV) since 2009, and managers were fighting the City regulator’s heavy-handed application of cost-disclosure rules. These made trusts seem far more expensive than other actively managed funds.
While there are many advantages to owning an investment trust over an actively managed fund, not least trusts’ closed-ended nature making them suitable for holding illiquid assets, they will always be lumped with the actively managed sector and compared with passives.
Active management will always be more expensive than passively managed funds, and there will always be more risk involved in picking stocks. For the past decade, moreover, there has been a growing shift from active funds to passive funds. Around 92% of the money invested by UK investors over the past decade has been placed in passively managed index-tracking vehicles.
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The good news is that these cost-disclosure rules have been reformed. The changes are already having an impact on the sector. RIT Capital Partners, which disclosed an annual cost of 3.8% under the previous rules, has republished its fact sheet with the cost revised to zero. Following the changes, Fidelity International has reinstated trading in the fund on its platform. It had previously removed the trust, citing the Financial Conduct Authority’s value-for-money requirement under the consumer duty rules.
What does this mean for investment trusts?
Unfortunately, even with these changes, investment trusts, especially smaller ones, are likely to keep struggling. This year is going to be a record-breaking one for trust mergers, with a near double-digit number of deals signed. Only seven mergers were agreed in the four years between 2016 and 2020. The largest deal was the £5bn merger of Alliance Trust and Witan Investment Trust, where the smaller Witan chose to merge with its larger rival following the retirement of its CEO Andrew Bell. The fact that Witan’s board chose to merge the fund rather than continue as a stand-alone entity is telling. Witan’s board said the combination was in the best interests of shareholders and allowed “the continuation of our multi-manager approach at lower fees and in a larger, more liquid vehicle”.
If Witan, worth £1.6bn before the merger, was worried about size and liquidity, what does that say about the landscape for smaller sub-£1bn trusts in general? It is getting harder and harder for them to survive. Baillie Gifford’s Keystone Positive Change is winding down. Aquila European Renewables plans to do the same now that a discontinuation vote has passed, and so has Residential Secure Income.
The £101m company followed in the footsteps of other real estate investment trusts (REITs): Abrdn Property Income, which decided on the wind-down route after shareholders refused to back a merger with Custodian Property Income Reit; and Ediston Property Investment Company, which sold its whole portfolio to US-based Realty Income.
These trusts traded at persistent discounts, with no clear long-term objective for realising value. As it remains out of favour, the sector is likely to keep consolidating and returning cash to investors. Investors are still willing to back actively managed funds and investment trusts, but the numbers do not seem large enough to enable the smaller trusts to survive.
The question is, who’s going to be brave enough to buy illiquid, sub-scale trusts trading at a discount, especially if they’ve underperformed? That’s something investors should ask when looking at their fund holdings. Even if something looks cheap, there will never be an opportunity to unlock the value without someone on the opposite side of the trade.
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