David Prosser explores how mergers and acquisitions of investment companies could prove exciting for investors.
Investment companies aren’t like other collective funds; they are independent companies, with shares listed on the stock market and boards of directors who have legal duties to protect the interests of shareholders. Often, this distinction doesn’t matter – the job of an investment company, just like any other fund, is to manage investors’ money as best it can. Sometimes, however, the difference proves to be significant.
The announcement of the $467m takeover of Round Hill Music Royalty Fund is a case in point. The fact that an investment company is listed on a stock market means it can easily become a takeover target. Another company can build a stake in it by buying its shares – and eventually make an offer to buy the whole thing. That’s exactly what’s happened with Round Hill Music Royalty, which is being bought by the American company Concord.
For investors, these deals can be valuable. The price Concord has offered for Round Hill is 67% higher than the price at which shares in Round Hill were trading on the day before the deal was announced. All of a sudden, investors in a fund that has been struggling in recent times are getting a significant boost. In this case, the board of Round Hill has recommended accepting an offer.
In fact, analysts at Stifel think this deal could be the first of a series of similar transactions involving investment companies investing in alternatives – that is, assets other than equities, including infrastructure, commodities, renewable energy and debt. Many of these funds are currently significantly undervalued, says Stifel.
Indeed, shares in equity-focused investment companies currently trade on a discount of 12% to the value of their assets, barely changed from the 11% average of a year ago. Discounts in the alternatives space have slipped from an average of 8% to 23% over the same period.
“Alternatives come with extra risks such as portfolio valuation, asset liquidity and often higher leverage, but in our view the extreme and historically unusual disconnect [with equity funds] highlights the oversold nature of the alternatives space," Stifel’s analysis concludes.
"The fact that an investment company is publicly listed can provide its investors with some important comfort. If the market doesn’t recognise its true value, there’s always the possibility that a buyer will swoop in to offer a fuller price."
Predictions of a spate of deals may or may not be proved right – and it’s very difficult to anticipate which funds might be targeted and when. However, there’s a broader point here. The fact that an investment company is publicly listed can provide its investors with some important comfort. If the market doesn’t recognise its true value, there’s always the possibility that a buyer will swoop in to offer a fuller price.
Moreover, the directors of the investment company are duty-bound to consider such offers. They’re not managing a product, where the commercial instinct to protect fees and revenues can be powerful; rather, they are stewards of shareholders’ interests, who must respond to takeover interest with a rational assessment of whether it makes sense for investors to recommend what’s on the table.
The reality is that investment company discounts – and premiums – are an inevitable consequence of the structure of these funds. Sometimes, market sentiment means the fund’s share price gets out of sync with what’s going on in the portfolio. That can be frustrating for investors, but M&A activity provides a potential route out of a persistent or extreme discount problem.
In the longer term, discounts are likely to correct naturally. Many funds are already intervening to bring discounts down, but as sentiment improves more widely, so too will valuations.
Still, for those unwilling or unable to be patient, a round of M&A activity could prove exciting.