Merger magic

The broad pick-up in corporate activity among investment trusts continued through 2023 in the face of another difficult year for the closed-ended sector. As well as manager changes, share buybacks and even fund closures, four mergers went through during the year, with another four scheduled to complete in the first half of 2024.  

This trend for investment trusts to become fewer and larger has been driven by the need to become more marketable, efficient and cost-effective for shareholders. It’s partly a response to the wider economic climate of recent years, which led to historically wide average investment trust discounts in 2023.

Indeed, for Peter Walls, manager of the Unicorn Mastertrust, persistent discounts are central to boards’ interest in mergers. “Let’s face it, if all investment trusts were trading at or close to their net asset value, there would not be much call for or rationale for mergers,” he argues. 

Walls adds that consolidation in the institutional and wealth management markets has also “led to demands for fewer larger investment trusts and the shunning of anything ‘small’.” 

Shareholders in merged trusts are likely to benefit from an increase in their trust’s size in various ways, including reductions in cost (the costs of one accountant, one company secretary and one board, instead of two of everything, for instance); economies of scale, as fixed costs are spread over a larger asset base; lower management fees, which can potentially be negotiated; and greater liquidity, making it easier to buy and sell shares. 

Typically, says Walls, it’s most likely that trusts with strong track records and good discount management records will propose a merger with a smaller, weaker peer with discount issues.

For example, in 2023 Shires Income took over abrdn Smaller Companies Income – in which it already had a significant holding – because of increasing worries about abrdn Smaller Companies Income’s volatility and its persistently wide discount, according to Shires Income chair Robert Talbut. 

“We believed that we could do a better job for our shareholders by holding some smaller companies directly rather than through another vehicle,” he explains, though the benefits of greater size were another major consideration. Both managers supported the merger.

For Rosemary Morgan, chair of the board of Nippon Active Value – which last year absorbed both Atlantis Japan Growth and abrdn Japan – the opportunity to grow significantly and strengthen the retail base was also a key consideration in the takeovers. 

“The great thing about the mergers was that we got a sizeable group of retail investors, which helped us build scale,” Morgan notes. The mergers doubled Nippon Active Value’s size to around £330 million, while the expansion of its retail investor base boosted liquidity and shareholder diversification. 

“The involvement of retail investors is attractive to institutional investors. They like the fact that we are a more diversified entity,” she adds. 

What’s involved in a merger? The process typically starts with discussions between the chairs, with the boards eventually reaching agreement on the future investment proposition and terms of the deal. In most cases, one trust is liquidated and its assets are transferred to the other. 

However, Gay Collins, a director of Dunedin Income Growth and an investment trust PR specialist, makes the point that chairs and their boards do have to prioritise shareholder interests in these discussions. “Turkeys don’t vote for Christmas, so it can happen that a very good merger idea gets rejected by the chair or the board because they don’t want to lose their jobs,” she observes. 

As Ryan Lightfoot-Aminoff, an investment trust research analyst at broker Kepler Partners, explains: “Some mergers may see some of the board of the merging trust join the ongoing board, but this is not always the case, and is done by negotiation.” 

When the deal is agreed, investors are sent a document outlining the terms and their voting instructions. This might involve voting via a shareholder meeting or returning an acceptance form. There is always a default arrangement for those shareholders who don’t respond.

Beyond voting, investors may have other decisions to make, with one of the most common alternatives being whether to receive some or all of their holding in cash – usually at net asset value less costs. That could be an attractive opportunity for many stuck in a trust trading persistently at a substantial discount. Even if they take shares rather than cash, the merged trust may command an improved rating. 

The board of the trust will usually provide a recommendation and explanation of their reasoning for shareholders – though Collins warns that there is a danger such documents are heavy on ‘legalese’ and not user-friendly enough for the retail market. “As a PR company we spend time ensuring there is at least a summary of why the merger’s happening and what its benefits are to shareholders,” she says. 

Boards don’t generally include recommendations for details such as electing for cash versus taking new shares, but Lightfoot-Aminoff adds that they “may provide details of the intentions of the board members in that respect”.

Rosemary Morgan recalls that the Nippon Active Value deal involved “much work behind the scenes, to bring about meetings for shareholders to decide whether they wanted to merge. Each party had to arrange a shareholder meeting and Nippon Active Value issued a new prospectus to explain the rationale for the transaction and the expanded fund.” On completion, Nippon Active Value’s traders sold the positions inherited from Atlantis Japan Growth and abrdn Japan and reinvested the proceeds into its companies.

About one-third of all shareholders voted, and over 99% who voted in October 2023 supported the merger, Morgan adds. “The whole experience of merging three trusts has been exceedingly positive.”

Talbut is equally enthusiastic about the way the Shires Income deal went: “All shareholders in both trusts were eligible to vote on the terms of the deal and we were pleased with the significant support shown for the transaction.”

So, while Walls makes the point that a merger would be unlikely to get off the ground unless the boards and managers on both sides were confident of shareholder approval, it’s increasingly important that retail investors actually engage with such fundamental changes given their rising profile within the closed-ended arena. 

As Morgan observes: “We welcome shareholder interaction and the involvement of the various investment platforms in facilitating the participation of shareholders to vote. It is very important that retail investors are involved.”