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The big trends shaking up investment trusts · On The Money

• 0:03
  Kyle Caldwell: Hello, and welcome to the latest episode of On the Money, a weekly look how to make the most out of your savings and investments. In this episode, we're gonna be focusing on some key developments that have been impacting investment trusts. Joining me to discuss this topic is Dave Baxter, who is senior fund content specialist at Interact Investor. Dave, thank you for joining me.
• 0:23
  Dave Baxter: Pleasure.
• 0:25
  Kyle Caldwell: So, Dave, to start off, I just want to get across that we are both big fans of investment trusts. For those that are maybe less aware than others, so investment trusts, they like a fund, they invest in a selection of different types of investments. However, there are some differences between an investment trust and a fund. One of the big differences is that an investment trust is a company that's it's listed on the UK stock exchange, and that there's two parts to an investment trust. So there's the share price, which fluctuates with in terms of supply and demand, And then there is also what's known as the net asset value or the NAV.
• 1:03
  This reflects the value of the underlying investments that are held within the investment trust. You quite often see investment trust trading on a discount, which means that the share price is trading below the value of the underlying investments. And in some cases, an investment trust discount gives investors an opportunity to potentially pick up a bargain. However, and as we're gonna talk about, Dave, that's not always the case. Another difference between an investment trust and a fund is that investment trusts have independent board members, and it's their duty to act in the interest of shareholders.
• 1:44
  And they they even have the power to change the full manager or the full manager group that is running the investment trust. Now a problem that investment trust boards have been seeking to try and solve is the fact that investment trust discounts have been trading on wide levels for around three, four years now. The typical investment trust has been trading on a discount of around 15%. Dave, to start off with I mean, there's not just one single answer to this, but what what for you are the main reasons why investment trusts have been trading on these stubbornly wide discounts for a couple of years now?
• 2:22
  Dave Baxter: Yes. So it's interesting. So I guess trusts do structurally tend to be on discounts anyway, but as you mentioned, they've widened out since around 2022, maybe late twenty twenty one. There's a few culprits that stand out to me. One is interest rate rises.
• 2:39
  That sort of sent a bit of a shock through markets anyway, and in particular, maybe some kind of popular trusts and some more kind of growth focused trusts. So that was the thing. And while we've seen discounts kind of come in a little bit this year, they still haven't completely recovered. Some other things to mention. One big structural issue is wealth managers.
• 3:08
  So they, I suppose, are kind of professional buyers of funds. They have been consolidating over the years, so gobbling each other up, and wealth managers are getting bigger and bigger and bigger. This means that in order to hold a trust, they now need the trust to be bigger so that it's kind of liquid enough for them to trade in and out. So that is kind of, I suppose, limiting the number of buyers for given trusts, which is probably also kind of holding those discounts out. And then I suppose a couple of other things are worth mentioning.
• 3:40
  One, it's a bit of a vague idea, but you might just have a kind of a spiral of sentiment. You know, people keep talking about the fact these discounts are persistent, and therefore, people are kind of seeing the investment trust sector as being in crisis and not really kind of wanting to touch it. And then finally, this is maybe a bit of a consequence of the rate rises that we mentioned, but investors might still be a bit uncertain or a bit unconvinced about the valuations on certain assets, so things like private equity, things like infrastructure. They might feel like they don't know what the true worth of it is in an era of higher rates where those assets are in theory less valuable.
• 4:23
  Kyle Caldwell: Going back to your points on the consolidation within the wealth management industry, what this means is that if an investment trust has assets of less than 300,000,000, they're not really gonna be on the radar of a wealth manager. They're not gonna be able to have enough liquidity for the wealth manager to buy in that type of investment trust. I'm gonna come on to this in a moment. We have seen an uptick in investment trust mergers over the past two years in particular. And one of the reasons behind that is because investment trust boards know that there's an increased importance in terms of having scale.
• 4:57
  I mean, for a retail investor, that doesn't mean you can't look for investment trusts that are below 300,000,000. And indeed, in some cases, some of them might be a potential hidden gem. However, the main thing to watch out for for retail investors with an investment trust that's got a small amount of assets is the bid offer spread. Because there there there are instances where the bid offer spread is pretty wide due to the fact that it's got a smaller amount of assets. In terms of investment trust discounts, I think sometimes it's not completely understood in terms of how to compare an investment trust discount.
• 5:38
  So I think, ultimately, with with investment trust discounts, they don't converge to net asset value. They tend to converge to their mean discounts over time. I think that's a better sort of proxy to look for rather than think, okay. An investment trust trading on a discount of 15%. So what this means is that over time, that discount may go go to NAV, net asset value.
• 6:06
  You know, if if it's trading on a discount of 15% and it's been on a discount of 15 for the past five years, then arguably, it's potentially not gonna be a bargain.
• 6:15
  Dave Baxter: Yeah. I think it's also worth mentioning that discounts people maybe sometimes get a bit too worried about discounts. It's not necessarily the end of the world. It does open you up to the risk of sort of corporate action of different kinds, but there are many cases, and this used to be the case with private equity trusts where, you know, for years and years and years, they languished on these huge discounts. But if you actually look at the underlying share price returns, then you've done extremely well.
• 6:40
  Kyle Caldwell: And in terms of the other reasons why investment trusts are on wide levels, as you mentioned, Dave, interest rate rises, they have been one of the big causes of it. So, you know, we saw interest rates in The UK rise from rock bottom levels to peak of 5.25%. Obviously, we've now been seeing interest rates coming down, and the expectation heading into 2026 is that we may see another interest rate cut in the not too near distant future. However, those interest rate rises, what what what that has done is that's increased the level of income that an investor can receive from lower risk assets such as bonds and cash. And due to that, investors are less incentivized to take greater levels of risk when you can get a yield of, say, four, four and a half percent on a very low risk asset like cash or a money market fund?
• 7:33
  Dave Baxter: Yeah. As we've discussed, money market funds are stubbornly popular, and maybe we will see that kind of shake out as rates come down. But even, you know, you look this year, you've had a context where equity markets are racing ahead. So how much is it gonna take to kind of draw people back into those risk assets, I suppose?
• 7:51
  Kyle Caldwell: I touched on earlier there's been an uptick in investment trust mergers over the past two years. So just to quote some statistics on it. So in 2024, it was a record year for investment trust mergers. 10 took place. Probably the most prominent one was the merger of Alliance Trust and Witten to create Alliance Witten.
• 8:13
  This year, we've seen some other mergers take place. So there was Henderson European Trust merged into Fidelity European Trust, and another tie up saw European assets merge with the European smaller companies trust. However, a recently proposed merger, which in fact is actually now being abandoned, was the proposed combination of Heckel Infrastructure and the Renewables Infrastructure Group. Dave, you've been covering the developments of this proposed merger, which have been proven controversial. Could you talk us through the the tale of the tape?
• 8:50
  Dave Baxter: So anyone who loves a bit of drama will have enjoyed this. It's been quite a, I suppose, tumultuous couple of weeks. So a couple of weeks ago from when we're recording this, they came out with the idea of this kind of mega merger, the Renewables Infrastructure Group and Heckel. Both infrastructure trusts would create a, you know, vehicle with great scale, and they said it had a good sounding from some of their kind of bigger shareholders. However, it quickly hit the buffers.
• 9:17
  You saw Hickle shares kind of tanked a bit. Trig shares conversely rose. But a lot of people took issue, I suppose, with the nature of the merger because what you'll be doing is you'll be combining so called core infrastructures, what Heckel holds, things like, you know, hospitals, roads, that kind of stuff, with renewable energy infrastructure, which is subject to so many more moving parts and has had a lot of challenges in the last couple of years. So opposition mounted. About a week ago, we saw a group of shareholders who had something like a combined 13% of Heckel saying that they opposed this.
• 9:56
  It's been Heckel shareholders in particular being against it. And now on the morning of the day we're recording this podcast, we saw it get abandoned.
• 10:05
  Kyle Caldwell: Yeah. As you mentioned, Dave, it it you know, they they invest in the same sector, but it's a very broad sector. And the assets that they both hold are not like for like. So if going back to Alliance Witten, that was a much cleaner merger. They both had a multi manager structure.
• 10:20
  They're both dividend heroes. That to me was pretty you know, I can see why that got the go aheads, why that got the green light. Whereas with this one, and and the main opposition to it was the fact that they're investing in different types of infrastructure assets. And if, you know, if if you're a shareholder in HICL, then, you know, you're you're buying it because you want exposure to that that part of the infrastructure sector rather than own an renewable infrastructure, which which is which is completely different asset mix in terms of type of investments. You wrote a story, Dave, in which there were a number of investors who are clubbed together in opposition of this proposed merger.
• 11:01
  Could you talk us through that?
• 11:03
  Dave Baxter: Yeah. So, again, this really kind of built up the drama. You had CG Asset Management, which runs the portfolio on the Capital Gearing Trust. That's a wealth preservation trust. They were initially really, you know, coming out really hard against this deal.
• 11:19
  They described it as appalling, and they, yeah, had some of issues we've highlighted. You're mixing different sectors. They felt like, basically, it would be fine if you already held both Hickle and Trigg. But if you're a Hickle shareholder, you were kind of getting a a raw deal because you're I suppose in recent years, renewables have just had so many more issues. Heckel invests in so called core infrastructure, which is quite slow and steady in some ways, whereas renewables have had a lot of problems.
• 11:52
  So, yeah, they basically kind of come out against that for those reasons. To mention some other criticisms, issue has been taken with the fact that Infrared, the investment manager of both trusts, is, I suppose, potentially benefiting from this, and the deal would have allowed Trigg to avoid a continuation vote due next year. And the thing that's really irks quite a lot of shareholders is the fact that the four boards are keeping their jobs. So you would have basically ended up with an 11 strong board, which is enormous. Our columnist, Ian Cowie, was looking at some of the numbers and kind of what cost it would have been.
• 12:33
  So all those things mounted up to basically lead to many people opposing this.
• 12:38
  Kyle Caldwell: And while there has been an uptick in mergers, which as mentioned, it's because there's there's now an increased focus among investment trust boards on scale and also an increased focus on trying to rein in a discount or or at least control a discount that doesn't spiral to a really high level. The big story in the investment trust world over the past twelve to eighteen months or so has been The US activist investor called Saba Capital. So around this time last year, the investment trust industry was rocked by Saba Capital sort of coming onto the scene and launching a campaign to try and oust the boards of seven investment trusts. And those seven investment trusts were EMBRA Worldwide, Keystone Positive Change, Bailey Gifford US Growth, the European Smaller Companies Trust, Henderson Opportunities, CQS, Natural Resources Growth and Income, and Herald Investment Trust. So SABA requisitioned general meetings of all those seven investment trusts and asked shareholders to vote on whether the board should be ousted out of all of those seven investment trusts.
• 13:48
  Now while SABA was unsuccessful in its campaign. Shareholders did vote against the proposals, and the board members retained their places for all seven of those investment trusts. It did lead to a fair bit of change. Some of those investment trusts no longer exist, and others have introduced certain policies to try and appease shareholders and trying and trying to make their investment proposition potentially more attractive.
• 14:17
  Dave Baxter: Yeah. So I think it's been you know, so much has happened that it's almost quite difficult to keep up with. But to summarize some of it, you had Keystone positive change, and Henderson opportunities ended up basically disappearing. So they did a they both did a kind of wind up where you had the option to roll over into an equivalent open ended fund. So that allowed Saba to get out closer to NAV and shareholders to do so as well.
• 14:46
  Some of the trusts ended up, I suppose, having a harmonious conclusion to the kind of SABA fight. So you have the CQS trust and European smaller companies ended up getting Saba off of the shareholder register by holding a tender offer. But then interestingly, you actually have a few names. So Herald, Bailey Gifford, US Growth, and Edinburgh Worldwide who are still stuck with Saba. Saba is still something like a 30% shareholder there.
• 15:19
  So they're kind of in limbo for the time being.
• 15:22
  Kyle Caldwell: Let's come on to Edinburgh Worldwide. As you reach as you recently reported, Dave, Saba has now come back again and requisitioned another meeting with Edinburgh Worldwide. And, again, it's calling for the whole board to be removed. Now last time around, the ultimate aim of SABA was that it would run some sort of investment trust or ETF that would invest in investment trust discount opportunities. However, so far, it's simply asking for the board to be removed.
• 15:56
  It's there's no sort of it's not stated publicly what its intentions are after that after that after that are you know, if if if it is proven successful and then there are new board members introduced, it's not then said what would then happen next, whether the investment strategy would change, whether it would try to be its full manager. Dave, could you you run through the reasons why Saba has returned?
• 16:22
  Dave Baxter: Yeah. So they issued an open letter to the board. They have bemoaned, I suppose, basically, sort of inactivity on the part of the board since they survived the attack earlier this year. So they've argued that performance hasn't been good, and there are different sides to that argument. And they've also complained that the board has carried out an inadequate level of share buybacks.
• 16:49
  I suppose in my mind, the issue is more, as I mentioned, that Saba has a really big position there, and what they would want is to get out. So they would require the board to do something like a big tender offer like the CQS Trust or European smaller companies did so that they can get out at a profit.
• 17:07
  Kyle Caldwell: Yeah. And they wanna get out at a lower level of discounts. Or, ideally, they wanna get out as close or at net asset value, at the value of the underlying portfolio rather than the share price trading below it. In terms of other investment trusts that are in Saba's sites, you've got a list from WinterFloods, which which highlights the investment trusts in which Saba is a mate well, a big shareholder in typically more at least 10% or more in terms of in terms of its position. Are there any trends within the types of investment trust that Saba is targeting?
• 17:43
  Is it simply a case that they're looking at out of favor investment trust? They've not they've not been performing well over the past three, five years. And in some cases, that's down to the investment style or the area of the market that the investment trust is focusing on.
• 17:59
  Dave Baxter: So I think they are looking at out of favor trusts, and they are looking where discounts are pretty wide so that in theory, if they can do a tender offer or that kind of thing, they can make a decent profit versus their original investments. I think there's a couple of interesting trends here. So you have there's still kind of a saber backlog. We've talked about the original targets, but there's also lots of different trusts that it's held for quite a while. So you have various UK small and mid cap names, like, for example, Schroeder UK makeup, Blood Rock, Thrug Mawson, where it has big stakes.
• 18:33
  It also has a really big stake in Crystal Amber, so that's quite a niche UK small companies fund. It's actually already been in wind up for quite a long time. Although recently, it now has one remaining position. It thinks it can kind of hold on and get a, I suppose, more profitable exit from that position further down the line. So the trust has basically chosen a new investment manager and wants it to kind of oversee that.
• 18:59
  So that's maybe the first wave of kind of positions that Saba has. What's really interested me in recent months is so, you know, I I interviewed Sabra in an old job. Must have been January. And at the time, they were saying they didn't really want to hold things outside the equity space because they wanted to be able to accurately value the positions, and they didn't know how to value kind of unlisted assets. But what we've seen in recent months is they've begun to take up kind of so called alternative asset class trusts.
• 19:38
  So battery storage funds, a week or so ago, they disclosed a position in Pantheon International with the private equity name, things like Malton Ventures. And that's kind of fascinating because they're potentially chasing bigger discounts, but they might struggle to use some of the techniques they've previously used to get out quickly because the portfolios are not very liquid, and you can't suddenly, you know, liquidate load of private equity assets in order to do a tender offer, that kind of thing.
• 20:10
  Kyle Caldwell: For me, as a retail investor, I think if, you know, if if I owned any of those investment trusts that Saba have big stakes in, and they're applying pressure on the board to rein in a discount, if that discount narrows, then that gives the retail investor a better opportunity to get out at a better price if indeed they wish to do so. So, you know, I've mentioned a lot of these investment trust that it's targeting, they've been out of form. In a lot of cases, it's it has been the investment style or the area the market invests in. It it it's faced a lot of headwinds, and that that has not helped performance. But if you wanna you know, if you're if you're unhappy with performance, then a narrowing discount gives you the opportunity to get out at a better price.
• 20:54
  Now we've seen SABA have success in certain areas. So early this year, Middlefield's Canadian income turned from an investment trust into an ETF. And we've seen in recent weeks, Smithson proposed to turn from an investment trust into an open end of funds. So Saba holds around 17% in Smithson, and, you know, they've clearly used their influence. They don't want Smithson to be trading on a wide discount.
• 21:26
  They they want that discount eliminated, and that has led Smithson to propose to turn into an open end of fund.
• 21:32
  Dave Baxter: Yeah. It's interesting. I think it's interesting to explore whether we would see more of that. I did have a quick look at some of those trusts listed by SABR, and it's hard to tell in the face of it whether that could apply there. But I did create a handy checklist of features which might make it easier to convert into an ETF, into an open end to fund that kind of thing.
• 21:56
  So it might simply be if you're not using or reliant on the features of an investment trust. So for example, you don't need to use gearing. You don't have the kind of massive position sizes that are not always permitted in an open ended structure. And importantly, you hold stuff that is, you know, pretty liquid, and you don't need the closed ended structure in order to do that. So it'll be interesting to keep an eye there and just see whether SABA does end up pushing for more of that kind of action.
• 22:28
  Kyle Caldwell: Yeah. I think the areas of the investment trust industry in which SABA's not really looked at at the moment, I think won't well, I'm assuming it has looked, but it's it's not ventured into are those investment trusts that have a really long track record of growing their dividends year in, year year out. They're using the the structural advantage that investment trusts have of being able to retain 15% of income generated each year into a dividend reserve. What that means is that when when an investment trust has a lean period is when there's less dividends coming in, then the investment trust can dip into those reserves to keep income pay payments flowing or maintaining the level of income. I think for, you know, for a lot of investors in those types of investment trusts, they they are buying it primarily due to the fact that all things being equal, the income generated each year should be maintained or should go up, especially if if it has got a lot in dividend reserves.
• 23:28
  So I think I think those types of investment trusts, I I could never really envisage seeing them turning into an ETF or an open ended format because they're using the structural advances that investment trusts have in terms of being able to put away a certain amount of income each year to then pay at a later date.
• 23:47
  Dave Baxter: Yeah. And I suppose we're seeing kind of that driving popularity for those names. You know, earlier we were discussing names like City of London that tended to trade on small premiums. So they are clearly in lots of demand and also therefore not really a bargain that Saba can pick up at least at the minute.
• 24:04
  Kyle Caldwell: And to end, I wanted to touch on share buybacks. So this is one of the tools that Investment Trust Board has in order to try and rein in or keep a discount broadly at a similar level over time. However, as you know, Dave, these, you know, these share buybacks, they're they're certainly no panacea. Ultimately, if an investment trust isn't performing well, if it's not doing something sufficiently different from the wider market, then, you know, what share buybacks then do is they'll they'll shrink the size of the investment trust rather than stimulate demand. I think performance is key.
• 24:44
  And going forward, you know, we've had ten, fifteen years of global stock markets performing really well. We don't know how they're gonna fare in the future over the next ten, fifteen years. But I think due to how well global stock markets have performed, a lot of investors are now taking the view of, well, if you just own the market, you've done pretty well. Like, so what you know, why was I trying why was I trying you know, why should why would I try and go down the active management route in order to beat it? Because and as we know, with an active funds, there is the opportunity for outperformance, but then there's also the opportunity for underperformance, and in some cases, quite vast underperformance versus an index.
• 25:24
  Dave Baxter: Yeah. It's I agree. It comes down to performance. It also comes down to doing something distinctive. The problem, I suppose, with the idea of being distinctive is, as you've said, equity markets have just done incredibly well in recent years.
• 25:38
  So doing anything different to the index has been, you know, if not extremely painful, it's been very easy to underperform. But perhaps we'll see things turn around and then see things change.
• 25:51
  Kyle Caldwell: And one final trend to note is that we have seen a bit of a rise over the past couple of years in what is known as performance linked tender offers. So, essentially, if you if you remove the jargon, what in that some some investment trusts have implemented is they've said, if we don't beat a compatible index over a certain time frame, such as five years, then we'll offer our shareholders an escape route. There'll be a certain percentage of shares that can be what's known as tenders, and you can get out of that investment trust at close to net asset value.
• 26:27
  Dave Baxter: Yeah. I think it's a good mechanism and one of the many things trust can use to perhaps ease people's concerns about underperformance. Although the question is if you have a, you know, performance linked tender offer on a three year basis, is someone gonna stick with the trust that long if it's kind of not delivering the goods?
• 26:45
  Kyle Caldwell: And just to put some figures on this. So since the start of 2024, 12 of the 22 investment trusts that have a performance related tender offer have since put one in place, so just over half have introduced a performance linked tender offer. And among the four managers that have introduced, such an arrangement are Bailey Giffords, JPMorgan, BlackRock, and Aberdeen for some of their investment trusts. These policies, they they provide a clearer exit opportunity for investors. But as mentioned, I think if I was in one of those investment trusts that had this sort of policy in place, I'm gonna be happy either way.
• 27:25
  I'm gonna be happy if performance has improved and that it's, you know, beaten a compatible index. And I'd also be, you know, potentially, you know, happy to get out at a better price. If indeed, I could then not see sort of scope for performance improving over time. Dave, thank you very much for coming on the podcast today.
• 27:44
  Dave Baxter: Thank you.
• 27:46
  Kyle Caldwell: And thank you for listening to this episode of On the Money. If you enjoyed it, please let us know what you think. You can comment on your preferred podcast app. And if you'd like to leave a review or a rating, that would be much appreciated. In the meantime, you can find more information and practical pointers on the Interact Investor website, which is ii.co.uk.
• 28:07
  And we'll be back next Thursday. Hopefully, see you then.