Moving in sync

Could the merger of Standard Life and Aberdeen Asset Management be held up by an issue with the portfolio of investment companies the latter manages? Citywire reports that City of London Investment Group (CLIG) is considering whether to throw a spanner in the works by seeking to prevent the transfer of a number of closed-ended funds in which it has stakes from an Aberdeen management contract to one run by the new group. That could make for some awkward conversations as the merger moves closer to completion.

CLIG’s issue with many investment companies – it has stakes in whole range of funds – is that they’re not doing enough to deliver value to shareholders; the discounts at which some funds trade relative to the value of their underlying assets are too high, it argues. The boards of these trusts aren’t always offering sufficient challenge to the fund manager, CLIG adds.

Now, this isn’t the place to debate the merits of CLIG’s case – either generally or in the specific instance of the Aberdeen funds it owns. But the disagreement does highlight a broader point that is worth discussing because it goes to the very heart of what an investment company is and does.

The fact that CLIG is able to fight its corner in this way should be welcomed by all investors, irrespective of whether they agree with its position. It can only do so because an investment company is a different kind of construct to other types of collective investment fund; while most such funds are products launched by a fund manager, which must then sell the investment case to investors, closed-ended funds are companies in their own right. They have a stock market listing, and appoint a fund manager to provide them with investment services; where the investment company isn’t happy with those services it can move to a new fund manager.

The distinction may sound academic, but it’s a crucial nuance. Open-ended funds are products offering very little accountability. Closed-ended funds are companies with a legally-binding duty to prioritise the best interests of shareholders; not only do they have independent boards whose job it is to serve those interests, but also, shareholders can assert their authority for themselves – by voting against corporate actions, for example.

The implications are fundamental. Get stuck in an underperforming open-ended fund and your choice is a stark one – sell up now and take your money elsewhere, or put up with the disappointment and suffer in silence. In an investment company, by contrast, investors look to their boards to intervene during periods of poor performance – possibly even by changing the fund manager. And if they don’t get the improvements or actions they believe are necessary, they have power of their own.

Does this mean investment companies will necessarily do a better job than other types of investment fund? Of course not – and investment company shareholders don’t always feel that they’re getting the performance they’re paying for, or even that the board is discharging its responsibilities (just ask CLIG).

However, this is an issue of alignment. In an investment company, the interests of shareholders and fund managers are aligned: the former need the latter to generate the best possible performance, while the latter worry that failure to do so will see them turfed out or obstructed by the former. That should be a comforting thought.