David Stevenson: What’s worked for trusts and where they could go next
Over the last few years many of us who are worried about the success, or otherwise, of UK investment trusts have focused on either structure or cyclicality. The former looks at issues such as regulatory reform and cost disclosure, while the latter consists of a hope that at some point, share price discounts will narrow, flotations will resume, and we’ll be back to a boom time like the late 2010s and early 2020s.
However, a better use of time might be to look at what’s worked within the investment trust spectrum and try to build on those successful strategies.
What defines success? Two easy measures come to mind: Impressive share price performance alongside an investment company that trades at a premium or very tight discount. This highlights a handful of themes.
The first is that the small band of corporate bond funds, including Invesco Bond Income Plus (BIPS ) and CQS New City High Yield (NCYF ), have provided investors with decent returns and trade either on above or slightly below par. The success of these funds, I would suggest, rather undermines the argument that bond funds don’t really work in the closed-end format. Clearly, they do, and it’s instructive that we’ve seen an explosion in the number of actively managed exchange-traded funds (ETFs).
I’d also challenge the view that open-ended funds are a more investor-friendly structure. More bond fund managers have found themselves chasing yield by moving into less liquid niches, pushing up against unit trust limits and reinforcing the argument for a closed-end fund structure.
The next theme is interrelated: Credit-based funds have performed consistently well over the last five years, with many generating yields in the 8%-10% range and trading at close to net asset value. Again, the lesson is clear—these are more illiquid asset classes, and they are perfectly suited to the investment structure.
Sadly, more mainstream credit shops are choosing instead to launch active ETFs to address the need for high incomes from many older investors and wealth advisers.
Sticking with the illiquid theme, I think the stunning success of 3i Group (III ), which is more a fast-growing low-cost retailer than a fund due to its large stake in Action, and, to a lesser degree rival HgCapital (HGT ), demonstrates one simple truth. If private equity shops can prove a track record in value realisation and growing businesses over a few decades, then the market does pay attention.
I know that’s not always true – rivals such as Oakley Capital Investments (OCI ) continue to trade at huge discounts despite their track record – but I think public markets generally reward a long record of overperformance and success, preferably over a few decades.
This brings me to an interrelated point: Skill and alpha. One of the few stand-out successes in the equity investment trust space has been the Ashoka stable of emerging market funds, with their initial Ashoka India Equity (AIE ) trust till trading at a premium. It helps of course that India is hot, and that it has an almost meme-like quality for private investors.
But Ashoka also boasts a long track record of superior stock picking, with a few, to be expected, ups and downs. By contrast, too many investment trusts have produced frankly sub-standard returns. There’s a reason why ETFs have become insanely popular and that’s because more and more investors have, rightly, grown cynical about the claims to superior alpha over a prolonged period of time.
Investment trusts were supposed to be the best of the best, the alpha managers who could prove their mettle and thus deserved long-term capital to manage. Sadly, in too many cases, this boast has not been delivered on. Slightly controversially, I maintain this view because the trust space became overpopulated by funds from big, well-known investment houses where alpha talent wasn’t nurtured properly or star managers quickly exited.
In too many cases, a smart investment house has had a huge success in one or two strategies and then launched funds across the full spectrum of asset classes, promising to replicate the formula – and all too frequently has singularly failed to deliver. This could all get much worse if the current consolidation process plays out: we could see large fund management houses replace whizzy boutiques by promising scale and efficiency but not alpha.
One area where the investment trust market has retained its mojo is in the value or equity income space. As the whole world seems to go momentum and tech crazy, there’s clearly an appetite out there for smart equity income strategies either specific to the UK or, more generally, to global equities. Well-established funds, large and small, have catered to this sizeable income-focused, defensive market, but the competition is waking up.
Last but by no means least, there are a few exceptional situations where the investment trust sector has come up with a great idea and then failed to capitalise on its genius. Take gold and gold mining equities. There was always a decent chance that precious metals would have their day in the sun again at some point, which would help underpin mining equity valuations.
London, along with Canada, has always had a great reputation for managers who can pick successful mining equities and a small sub-group of funds from the likes of BlackRock (BRWM ), CQS Natural Resources Growth and Income (CYN ) and Baker Steel Resources (BSRT ) have emerged to capitalise on this skill. Returns have varied, as you’d expect, but in the last 12 months funds like Golden Prospect Precious Metals (GPM ) have produced huge gains (up 57% in the last 12 months in price returns terms).
Unsurprisingly, over the last few years, the ETF competition has intensified, and there are now dozens of ETF tracker funds targeting everything from spot physical gold to junior gold mining equities. Yet, the London market still has only a handful of funds focused on this area, an area that I would have thought was perfect for the London funds market.
I’ll finish with one last slightly random thought. In the last year or so, I’ve been struck by the quantum of money moving into defence and security-related stocks ranging from our own BAE Systems (BAES) through to Palantir in the US. There are now at least five sizeable ETFs operating within this broad equity space, with more on their way, plus a long tail of cybersecurity-related ETF funds. Investor demand is huge.
And yet there’s no defence and security-related actively managed investment trust. Surely, if someone is looking to try out an IPO, this must be the biggest opportunity set in a liquid asset class that would, in my view, clearly benefit from the active alpha in the stock picking department.
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