How does the board represent shareholders?

David Prosser looks at the advantages of an independent board.

One of the major differences between a closed-ended fund and a unit trust or open-ended investment company is the way in which the former is governed. Like other stock market-listed companies, an investment company must have an independent board that oversees the fund manager on behalf of shareholders. An open-ended fund has no equivalent of this structure – the fund manager’s boss is the business that administers the fund rather than a representative of his or her investors.

The importance of this contrast shouldn’t be overlooked, but we don’t often hear from the directors of investment companies – the fund manager tends to be the public face. The interview conducted by Morningstar with Rachel Beagles this week was therefore welcome – Beagles sits on a number of company boards, including Securities Trust of Scotland and BlackRock Emerging Europe, and is keen to make the case for the sector.

In particular, Beagles stresses the importance of the board structure. “The board provides a unique layer of governance that has responsibility to act in shareholders’ interest at all times and that’s something that unit trusts don’t have,” she reiterates.

Why is this so significant? Well, for one thing, a strong board is able to get rid of underperforming managers – either the individual fund manager, or the fund management firm if that’s where the problem lies – and appoint replacements capable of restoring the fund’s fortunes.

Boards have also become increasingly proactive about tackling the discounts at which investment companies tend to trade relative to the value of their assets, a persistent bugbear of financial advisers and investors. Many have introduced discount control mechanisms that kick in automatically if the discount widens to a certain point. Others have less formal policies, but are tackling the issue nonetheless.

Another area of action for fund managers has been charges, where boards have played a leading role in reducing fees over the two years since the retail distribution review, simplifying charging structures and cutting costs for investors.

For Beagles, it is also increasingly important that investment companies make their pitch to investors and their representatives. “It’s important that we explain to the marketplace what advantages the investment trust structure does provide,” she told Morningstar.

In particular, she insists investors should not be put off by the fact that investment companies can and do take on gearing. Given the hope and expectation that markets will rise over time, the fact the sector can take advantage of this feature is in its favour, Beagles argues. She also points to the growing importance of investment companies for income-seeking investors, given the fact they are allowed to hold on to income so as to be able to pay consistent dividends over time.

These features are important, and Beagles thinks more advisers have begun to recognise the advantages investment companies can offer. “With all the investment trust boards that I sit on we're seeing increased retail ownership of our funds and I think with responsible action by boards and in the current marketplace I would hope that would continue,” she adds.

What the analysts say this week

Simon Elliott, Winterflood Securities

“2014 was a good year for investment trusts. The FTSE Equity Investment Instruments index was up 7.5 per cent on a total return basis, compared with a rise of just 1.2 per cent for the FTSE All Share. In our view, this outperformance is partially explained by the sector’s increasing exposure to non-equity asset classes, such as infrastructure, property and debt. This is reflected by fund-raising across the sector, which totalled £6.4bn last year. This included 17 IPOs, which raised £2.8bn. Yield remains a key characteristic; 12 of the 17 were targeting a dividend, while the average yield was 4.7 per cent.

“We remain positive on the prospects for equities over the long term, although believe that the current volatile market conditions could continue for some time yet. The impact from this on the investment trust sector should be alleviated by the growth of non-equity asset classes, which has been driven by the requirement for income. Listed closed-ended funds naturally lend themselves to income producing mandates and, with interest rates showing no sign of rising, we would expect the demand for income to continue this year.”

Charles Cade, Numis Securities

“In 2014, the overriding theme remained investor demand for yield, both from equity income funds and from alternative asset classes, including social infrastructure, renewable energy, property, and specialist debt. More than 115 investment companies are now trading at premiums, representing 40 per cent of the sector by value. The average discount for equity funds of 5.4 per cent is close to a historic low, while most alternatives are trading on premiums.

“RDR has had a positive impact on retail demand, and private wealth/multi-asset managers are continuing to see strong inflows. In addition, investment companies look well positioned to benefit from the transition in the UK savings industry as a result of the forthcoming pensions reforms. There were signs of IPO fatigue in the market in the second half of 2014, as in the broader stock market. Nevertheless, we expect to see significant further share issuance in 2015.”