James Carthew: Need to cut charges lies behind Abrdn and trust changes

The imperative to cut costs as well as boost assets is a big factor in the spate of mergers and manager changes we’ve seen from investment companies recently.

The pace of change within the investment company sector appears to be accelerating. Just in the last few weeks we have seen Asset Value Investors win the mandate to run MIGO Opportunities (MIGO ), though likely with the same management team as before, which is welcome news.

There has also been a suggestion from the chair of Henderson Diversified Income (HDIV ) that the bond fund’s investment approach might need a rethink, while a continuation vote has been called at ThomasLloyd Energy Impact (TLEI ) following the discovery of big losses on its construction project in India.

In addition, there has been a notable spate of announcements from Abrdn-run funds. Abrdn Smaller Companies Income (ASCI ) has confirmed a merger with Shires Income (SHRS ) while Abrdn New Dawn (ABD ) and Asia Dragon (DGN ) have unveiled plans to combine.

If we factor in an ongoing strategic review of Abrdn Diversified Income & Growth (ADIG ), the planned takeover of Abrdn Japan (AJIT ) by Nippon Active Value (NAVF ), and the recent liquidation of Abrdn Latin American Income, it is clear a substantial reorganisation of the group’s investment companies stable is underway.

In large part, this looks to be in response to demand from some professional investors for scale. I am not sure of the merits of pandering to this. The county council, insurance company and company pension funds that used to dominate many share registers used to be clamouring for this but are now a much-diminished presence in the sector. I think that they would have left anyway regardless of the actions that the funds took.

Today, it is the turn of the wealth managers, who seem to be combining forces into ever more unwieldy and inflexible behemoths, to say that investment companies no longer suit their portfolios on liquidity grounds. I think that they will eventually shun even the largest of investment companies.

That means that the future of this industry is in smaller wealth managers and the like, who are willing to run more bespoke portfolios for clients, and independent DIY investors. These investors have less reason to be bothered by scale, but they do care about fees.

Larger closed-end funds tend to have lower average running costs, as the fixed expenses every fund incurs are spread over a wider base.

Crunching Morningstar data, I looked at the annual ongoing charges of 346 London-listed funds. Of these, 21 had figures in excess of 3%, which is too much. Many of these are in wind-up mode and so the numbers are distorted as their asset bases shrink. The rest should be looking at ways to cut fees, and at mergers/liquidations if that is not possible.

Then, there are another 35 funds with ongoing charges of 2% or more. Some of these might be able to address the problem by expanding through share issuance, such as Rockwood Strategic (RKW ).

Abrdn Private Equity Opportunities (APEO ) features in this part of the list. However, it is there because, in part, it is a fund of funds, and so, in addition to the running costs of the trust, which are a modest 1.06% per annum, it discloses look-through costs on the underlying portfolio of 1.67%, making a total of 2.73%.

However, I would not get too fixated on this. While APEO could get around the problem by running a 100% co-investment portfolio and investing in unquoted companies alongside other private equity funds but not via them, thus reducing costs.

I am not sure that this would necessarily be to the benefit of its total returns. It is worth remembering that even after these fees APEO is one of the best-performing of all investment companies across a 10-year period in terms of the underlying growth in net asset value (NAV). Its shareholder returns of 222% rank highly too, despite the hefty 41% share price discount.

There are another 52 funds with ongoing charges above 1.5%. The overwhelming majority of these invest in alternative assets or have highly specialised mandates. Often the extra fee can be justified by the amount of extra work that the manager needs to do.

A good example of this is Abrdn Property Income (API ). It publishes two ongoing charges ratio figures. The annual running costs of the fund work out at about 1.1% of net assets. However, it also spends an additional 1% per annum on the direct running costs of the underlying properties, making 2.2% in total. The board cut Abrdn’s management fee by 10 basis points (0.1%) per annum with effect from 1 January 2023, so – if nothing else changed – this number should fall.

Apart from APEO and API, none of Abdrn’s other closed-end funds have ongoing charges this high. The next most expensive – in terms of running costs – is ADIG, coming in at about 1.4%. Again, it has the excuse of a specialist mandate that requires more work to manage than an equity portfolio.

At 1.34%, ASCI, which does have a conventional equity portfolio, appears expensive, although its investments are in the small company arena where there is less broker research and a wide universe to select from. The merger with Shires will address that, but comes at the price of a refocus away from UK small caps at a time when, as I have argued over the past few weeks, they are particularly unloved.

There is another argument for consolidation that explains the New Dawn/Dragon merger: why have funds within the same stable doing essentially the same job? The only real difference between the two was that ABD has exposure to Australia within its portfolio and its benchmark, whereas DGN did not.

I thought it was interesting that Peel Hunt analyst Anthony Leatham highlighted the overlap between Abrdn’s four UK equity income trustsMurray Income (MUT ), Abrdn Equity Income (AIE ), Dunedin Income Growth (DIG ) and Shires – in the comment he made on the Asian merger. 

As I have stated, I do not think that the problem with any of these is that they are too small, neither are they too expensive to run. In my view, it is more that it is hard to differentiate between them from a marketing perspective.

Murray and Dunedin’s returns are very similar. Shires is a different beast, given it boosts its income with a geared portfolio of preference shares. An expanded Shires could be reimagined as more of a competitor to Henderson High Income (HHI ), which has achieved similar (but slightly better) returns from a mixed equity and bond portfolio.

Abrdn Equity Income’s future is more uncertain given its track record of returns towards the bottom end of the performance league tables. It might be the final piece of the Abrdn merger puzzle.

James Carthew is head of research at QuotedData.

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