David Prosser explains how the investment company sector’s corporate governance arrangements can work in investors’ favour.
Corporate governance really matters. It’s a concept to which we sometimes pay too little attention or regard as a “nice-to-have” but if no-one holds companies to account, disaster is very often the outcome. When organisations lack the people or structures to ask searching questions about how managers are looking after other people’s money, you end up with bankruptcy, scandal or even a financial crisis.
In this context, it’s great to see the AIC working a bit harder to explain how the investment company sector’s corporate governance arrangements can work in investors’ favour. The AIC hosts regular roundtables on key industry issues and investment issues, but an event last week was the first time it dedicated discussions to the role of investment company boards.
A quick reminder: closed-ended funds are incorporated as companies in the same way as other market-listed businesses; one consequence of this is that they must have an independent board of directors. The board has a legal duty to act in the best interests of the company’s shareholders – its investors, in other words.
This isn’t a dry and dusty issue with no relevance to investors. The AIC’s roundtable heard from both investment company managers and directors about what the board set-up means in practice. Very often, interventions by the board of an investment company have resulted in some uncomfortable conversations, followed by a better outcome for investors. The issue of performance is one obvious example. The best boards scrutinise their managers’ investment performance, set them challenging targets and hold them to account if they fall short. At the extreme, that may even mean changing the manager altogether.
Charging is a similar issue. One reason why we have seen charges fall across the investment company sector is that boards have put managers under pressure to reduce their fees, or to rethink charging structures to offer a fairer deal.
Or take the issue of discounts. There was a time when the shares of investment companies routinely traded at a discount to the value of the underlying assets of 20 per cent or more. Today, discounts are often single-digit; that’s due, at least in part, to a determined effort by boards to get on top of the problem. They’ve instituted formal discount control mechanisms or taken action in the market.
Of course, the mere fact that an investment company has a board is no guarantee of outperformance – and some directors obviously do a better job than others. Nevertheless, the structure itself has an intrinsic value: it sets the whole tone for how the fund is managed and why.
Never forget that an open-ended fund is a product – it is created, marketed and run by an asset management company with the aim, ultimately, of generating a profit for that company. A closed-ended fund is completely different. It’s a company in its own right, set up with the goal of delivering returns to its shareholders; the asset manager is simply a service provider that it pays to support this endeavour. That manager can be changed. Arguably, this is the most important distinguishing characteristic of the closed-ended industry of all. The more we talk about it the better.