Exercising judgement

David Prosser highlights the recent Strategic Equity Capital continuation vote and explains the benefits of shareholder democracy in investment companies.

judge gavel hammer decision

For fans of investment companies, seeing a fund survive a continuation vote usually provides a shot of goodwill. The strong vote this month against a wind up of Strategic Equity Capital is a case in point; certainly, the fund has some problems, but it is making efforts to address those, including appointing a new manager, who has only had a few months to steady the ship.

In the end, some 82% of investors in the fund said no to a pitch to close the investment company made by two shareholders; more than two-thirds of shareholders voted, which is not a bad turn-out. There may yet be twists and turns in this story, given that shares in Strategic Equity Capital trade on a chunky discount to the value of the underlying assets, but the fund has survived for now.

Still, the wider story here is one of accountability. There are not many products and services – particularly in financial services – where the end customer gets the opportunity to have the range discontinued if they do not think it is living up to their expectations.

But investment companies’ customers are a special breed. As shareholders in the funds, they are the owners of the business; as such, they may choose to close the business if they feel it is no longer serving their best interests.

Some investment companies offer continuation votes as a matter of course at pre-agreed times. In other cases, a wind-up vote may be triggered by a specific set of circumstances – a sustained high discount on the shares, for example. Either way, investors get an opportunity to hold the fund accountable; ultimately, if they are unhappy with the performance generated by the fund’s managers, they have the option of shutting up shop.

Wind ups often represent good news for investors looking for a way out of a situation they are not particularly happy with. They will typically be offered cash based on the fund’s underlying asset value (minus wind-up costs) rather than being stuck with shares that undervalue those assets. Or they may get the chance to transfer to a better performing fund. This is why investment company shares often spike higher on news of a potential discontinuation.

Above all, this is an exercise in shareholder democracy and a reminder of who the asset management industry should be working for.

In the open-ended funds industry, asset managers run hundreds of funds that never deliver the hoped-for performance, but investors’ only option is to cash in their disappointment and walk away; these funds are products offered by asset managers, with investors left to buy them or leave them. By contrast, the power dynamic in the investment companies sector is reversed. The asset manager is employed by the fund and its shareholders; this manager can be sacked if it does not deliver, or investors can put the fund out of its misery by winding it up. They are in control.

Every discontinuation vote has its own arguments, of course, and investors will often take very different views. It is encouraging to see funds survive because it means they have pleaded their case to investors successfully. But the most important point is that those investors have had an opportunity to exercise their judgement.