Talking takeovers
David Prosser on the spate of investment trust mergers and acquisitions.
Another day, another takeover of an investment trust. Downing Renewables & Infrastructure Trust is to be bought by Bagnall Energy, its largest shareholder, in the tenth bid for an investment trust this year.
There’s a couple of things going on here. First, most of the bids have been for investment trusts focused on alternative assets, particularly real estate and renewable energy. Shares in such funds have been trading at unusually wide discounts to the value of their underlying assets, largely because these assets are particularly sensitive to interest rates, which were rising for a time. Bidders have therefore spotted an opportunity to snap up assets with undoubted long-term potential at bargain-basement prices.
The other factor at play here has been the noise around investment trusts more generally. There continues to be a debate about the viability of smaller funds. Discounts across the industry remain unusually high, and investment trust boards have come under pressure to take radical action to protect the interests of their shareholders.
Takeovers are a sign that financial markets are working effectively – largely to the benefit of investors.
David Prosser
So, where does that leave us? Well, on the one hand, takeover bids leave shareholders in any company, including an investment trust, with some decisions to make. That can feel uncomfortable: bidders may be offering to buy your shares at a premium to the current price, which can be alluring, particularly if a fund has delivered disappointing returns of late. But selling up means giving up on potential gains to come from a fund you presumably chose because you expected it deliver over the long term.
It's also the case that takeover bids can be tough for investment trust boards and management teams to deal with. They will have both a personal and a financial interest in the fund; it can be difficult to put emotions aside to deal with a takeover situation rationally and calmly.
However, the big picture here is that takeovers are a sign that financial markets are working effectively – largely to the benefit of investors. Investment trusts performing strongly, with management teams exceeding expectations, rarely find themselves on the end of a bid, because a potential buyer will struggle to secure additional value. It’s when a trust is struggling, for whatever reason, that a bid is more likely to materialise.
Think of this as the market holding the investment trust to account. In recent years, boards of struggling trusts have worked hard to deliver turnarounds. For example, they’ve initiated share buybacks to reduce the number of shares in circulation in an attempt to get discounts down. They’ve cut charges. They’ve replaced managers.
Where that hasn’t delivered sufficient improvement, a takeover bid is effectively a pitch from a third party wanting a chance to make the positive change required.
This is a dynamic that only applies in the investment trust world. If you’re in an open-ended fund that isn’t performing, you can cross your fingers that the manager will take action to put things right, but there’s no opportunity for anyone else to ride to the rescue. Your only option, if returns don’t improve, is to sell up, crystallising your disappointment, in the hope of doing better elsewhere.
The stock market listing of an investment trust, by contrast, makes it possible for external bidders to intervene with the aim of driving change. Moreover, the board of the trust, with fiduciary responsibilities to shareholders, must judge any offer on its financial merits, even though they may feel personally unhappy about the prospect of a takeover.
In that sense, it would be a mistake to see the spate of takeover bids in the investment trust sector this year purely as a weakness of the sector. In fact, this round of corporate action also underlines the strengths of the investment trust structure and the benefits it can have for shareholders.
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