Hedge funds are pouncing on the UK’s £200bn investment trust sector as it is shunned by investors and hit by competition from cheaper rivals.
Investment trusts, a cornerstone of UK equity markets with roots stretching back more than a century, have seen a gap open up between their share prices and the value of the assets they hold while they battle the worst year for raising capital in a decade.
The discount, which stands at an industry average of 9 per cent to net asset value, has put some investment trusts on the brink of being wound up or targeted by hedge funds including Paul Singer’s Elliott Management and Boaz Weinstein’s Saba Capital.
Their troubles have weighed down the broader UK equity market. The FTSE 100 is closing in on its February 2023 record, in contrast with US and European indices that have hit a succession of all-time highs this year.
“Investment trusts used to be a uniquely British success story and a vibrant part of the market,” said James de Bunsen, a portfolio manager at Janus Henderson Investors’ multi-asset team. “That has totally gone.”
In recent years the trusts, which act as closed-ended investment funds, have become less popular as higher interest rates lured investors into government bonds. That pushed the discount rate as high as 17 per cent, its widest since the financial crisis.
The proliferation of alternative vehicles allowing easy access to a range of global assets — such as exchange traded funds — has also hurt the sector.
Investment trusts make up 27 per cent of the companies in the FTSE 350 index. They include Baillie Gifford’s flagship Scottish Mortgage Investment Trust, Bill Ackman’s £7.4bn Pershing Square Holdings, and the £2.5bn RIT Capital Partners trust.
They date back to the Victorian era, when they were created to widen access for individual investors to investments across the British empire. They offer a set number of shares, which investors can trade among themselves without affecting the pool of cash managers have at their disposal.
That makes it easier for them to invest in assets that are difficult to sell in a hurry, such as property or private equity. This is in contrast with open-ended funds, which constantly issue and redeem new shares or units in response to demand.
“Once upon a time you couldn’t buy shares in emerging market tech so you bought an investment trust,” said one hedge fund executive. “Today there are many ETFs that track emerging market tech and investors have a lot more choice; what was once a very unique product is not that unique anymore.”
Their woes, which are a further drag on London’s already underperforming stock market, have attracted the attention of activists who are pushing trusts to return capital to investors.
Last month Elliott disclosed a 5 per cent stake in Scottish Mortgage Investment Trust a week after the FTSE 100 trust announced a £1bn stock buyback to try and prop up its ailing share price. The US investment firm had been a shareholder for several months before the disclosure.
Saba has built a stake of about $1.3bn in derivatives and shares in UK trusts, according to a source familiar with the matter.
These positions include a £70mn stake in Baillie Gifford’s US Growth Trust, an $88mn stake in JPMorgan’s European Discovery Trust and a £62mn stake in the BlackRock Smaller Companies Trust, according to regulatory disclosures in the past few months.
Others are following Scottish Mortgage’s example. Industry buybacks hit a record £3.6bn last year, according to the Association of Investment Companies. Others have cut fees, closed or merged their funds, including the £1.2bn consolidation agreed by Fidelity and Abrdn last year.
“We strongly support the company’s recently announced £1bn buyback — the largest buyback programme ever announced by a UK closed-end fund — and look forward to continuing our engagement,” said Nabeel Bhanji, partner at Elliott, in a statement. Scottish Mortgage declined to comment.
But other investment trusts face a battle to survive. Capital raisings, the industry lifeblood for new funds, have dried up. Last year there were just two initial public offerings, worth a total of £43mn, while secondary fundraising dropped from £5.2bn in 2022 to £1.1bn, according to the Association of Investment Companies.
A number of investment trusts that invest in green energy have been unable to raise equity as a result of their discounts, fuelling fears that the sector’s woes are starving the UK of badly needed green investment.
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Many trusts are required to hold a vote if the discount between its share price and its net asset value hits a threshold. Several environmentally focused trusts, including the UK’s largest, the £3.2bn Greencoat UK Wind, are close to this threshold or have crossed it.
Elliott is not planning to sell its stake in SMIT, according to a person familiar with the fund’s strategy, who added that the investment trust has “more to do” regarding buybacks. However, Weinstein is considering several tactics, including share buybacks or pushing for fund liquidations in extreme cases. Saba Capital declined to comment.
Some fund managers also blame regulatory changes for choking demand. In 2022, the way investment trusts’ fees were presented to some investors was changed, in response to new guidance on rules originally introduced in 2018. Critics argue that the UK’s interpretation of the rules — which also cover EU funds — means British trusts’ fees are artificially inflated.
Last month, a group representing 109 trusts wrote to chancellor Jeremy Hunt warning that the current set-up “cannot be allowed to continue”.
It added that the rules were driving investors to EU-domiciled funds and exacerbating the poor performance of the UK stock market. A regulatory overhaul could unlock £7bn per year of lost investment to the UK at no cost to the taxpayer, it concluded.
“This is a self-inflicted own goal,” said Baroness Ros Altmann, who last year proposed a private members bill to change the regulatory requirements. “Other countries are taking advantage of our companies . . . the industry is dying.”
A Treasury spokesperson said: “We recognise [the] industry’s concerns and are working at pace with the FCA to repeal and replace EU-inherited retail disclosure rules, including for investment trusts.”
But activist hedge funds say the trusts must prove their value to investors, rather than waiting for government intervention.
“The reality is that some of these discounts are driven by things which are fixable,” said the hedge fund executive. “Sometimes you need to change the manager, sometimes the mandate, and sometimes the governance structure.”
Letter in response to this article:
UK needs to create a level playing field for investment trusts / From Sushil Wadhwani, London SE21, UK