Shareholder power and the role of the board

Whatever your views about the wrangling over the future of Alliance Trust, the disagreement between the board and a group of its shareholders actually paints the investment company sector in a positive light. That might seem counter-intuitive – a dispute with investors might be taken as a sign that a fund isn’t functioning effectively – but the arguments at Alliance speak to a very fundamental principle of investment companies.

This is that an investment company is a stock market-listed vehicle with a board of directors who have fiduciary responsibilities to shareholders. This board appoints an investment manager for the closed-end fund which can be hired or fired as the directors see fit. And shareholders can make their voices heard and even effect change – if enough agree – in exactly the same way as at other companies.

Why is this so important? In the simplest terms, the arrangement keeps the investment manager honest. If performance disappoints, particularly over an extended period, the manager knows the board has a responsibility to shareholders to think about whether changes are necessary. It also knows that these shareholders may seek to hold to it account directly.

None of which is to come down on one side or other of the Alliance Trust dispute, where one group of shareholders says performance has been disappointing and is now seeking to put new directors on the investment company’s board.

The crucial point, however, is that this discussion would simply not be taking place at a collective investment fund structured in a different way. An open-ended fund is the creation of the investment manager that runs it, rather than an independent company. The manager launches the fund with the aim of earning fees from investors who put money into it – good performance is obviously desirable since this will attract more investors and boost fee income, but poor performance does not lead to a confrontation with investors or moves to unseat the manager. There is no structure or process that allows for this to happen.

The dispute at Alliance Trust is an unusual situation – it’s rare to see such arguments played out so publicly or from such polarised positions. Nevertheless, conversations of a similar nature take place very regularly at a great number of investment companies, as boards question their managers on behalf of shareholders, and as those shareholders make their views known.

Take, for example, the recent changes at Monks Investment Trust, one of the sector’s longest-established funds. It has just completely replaced its management team in a bid to reinvigorate investment performance and the new man at the helm is in the process of a huge overhaul of Monks’ portfolio. Such a dramatic change would have been far less likely in the open-ended sector, where accountability is not so transparent.

Some financial advisers have in the past been put off investment companies by the structural differences to the open-ended sector with which they have traditionally been more familiar. But those who think the arguments at Alliance Trust are a reason for such views to harden should reconsider – as the structure of closed-ended funds gives shareholders a far greater say in the future of the company.