In light of the high-profile launch of Anthony Bolton’s China fund, investors are taking a greater interest in the role of investment trust directors than ever before, Joe McGrath discovers...

Last month, former Schroders Income & Growth fund director David Causer was appointed as a non-executive director of Fidelity’s China Special Situations fund, managed by Anthony Bolton.

Traditionally, investors, and indeed the media, have been reluctant to scrutinise the board members managing these funds, but being arguably the most famous investment trust launch of recent times, this news triggered a wave of interest.

Investors have always been undecided as to the exact impact of the board members running their investment trusts, with some hardly knowing the composition of the board at all.

More recently, the issue has become a topic of interest for Frostrow Capital’s managing partner, Alastair Smith. He noticed that there is a growing trend of corporate governance consultants advising investors to vote directors off the board, leading to some investors doing so after conducting little or no background research about the individuals concerned. He says, ‘I would urge shareholders not to take this principle at face value, but to assess all directors as a matter of course and to decide whether or not to retain them on merit.’

Ringing the changes
Smith cites the Biotech Growth Trust, managed by Frostrow Capital. In 2005, the fund’s directors changed both the fund’s mandate and its investment manager in a bid to improve performance.

When the fund launched, it had focused on Europe because, at that time, the board expected the relative importance of European biotech to increase. In the event, the US retained its dominance and biotech in the Far East began to grow rapidly.

Therefore in 2005, the directors widened the trust’s mandate to a global one and proposed that the trust focus purely on emerging biotech companies.

With these revised objectives, the board sought an investment manager with global expertise and appointed OrbiMed Capital, the world’s largest healthcare-dedicated investment firm. In addition, it adopted a policy to buy back shares in the market to protect a maximum 6 per cent discount to NAV per share, a policy that the fund has since stuck to.

Despite this, after some influence from corporate governance consultants, investors were advised that it might be in their best interests to vote off a number of the directors on the grounds that they had become stale as they had been in place for over nine years.

How the situation plays out remains to be seen, but it did highlight the issue of how  investors should evaluate the performance of investment trust directors.

Assessing the board
Arguably, the most important factor is whether the board has changed or reviewed the fund manager. In an investment trust’s annual report, the board has to declare that the continued employment of the investment manager is in the best interests of the fund. This would imply that the board has surveyed all other eligible managers and concluded that the incumbent fits the fund’s mandate better than any of the peers.

Also of significant importance is whether the directors have taken the time to evaluate their manager’s competition and the market as a whole. It may make sense to engage a third party to draw up a shortlist of investment managers, in case the incumbent ever needs to be replaced at short notice.

Frostrow’s Smith explains, ‘Some directors run the risk of becoming too friendly with the incumbent manager, much the same as analysts at investment banks have been accused of falling in love with the stocks that they rate.

‘There may be self-interested concerns; for instance, if a director votes to fire a manager that advises several investment trusts, then he or she may fear being blacklisted from future directorships. No matter how well the directors know the investment manager, replacing the latter should never be a taboo subject.’

The decisions that the directors have made should also be acknowledged, however. This is linked to the first point, because if performance deteriorates it is the duty of the board to review the manager or, in a worst-case scenario, wind up the fund.

Generally speaking, the board exists to govern the company. With regard to a manager review, the board needs to be comfortable that its investment manager really is adding value, not necessarily in the short term, but over the longer term.

Shareholders should review whether the directors have paid attention to the share price discount to the net asset value (NAV) per share. For example, is there a share buy-back strategy? This is a telling question because buying back shares for cancellation or holding in treasury at a discount is in the shareholders’ interests, but not in those of the investment manager.

Share buy-backs decrease the investment company’s assets under management and thus the manager’s fee. If the share price is volatile, however, the share price return to investors will diverge from the NAV return they expect to receive and which is, in most cases, why they bought the trust (and access to that manager) in the first place.

Tight control
Among others, Finsbury Growth & Income Trust has an exemplary track record for keeping tight control of the discount through share buy-backs and reissue from treasury.

Over six years since the implementation of the buy-back policy (to facilitate the exit of a large institutional shareholder) the discount has averaged approximately 1 per cent. This has meant that the share price return has, by and large, mirrored the NAV return delivered by Lindsell Train, the investment manager.

Existing shareholders, as well as those considering buying shares in a closed-ended fund, may wish to investigate whether the directors themselves own shares and whether they have been selling or adding
to their positions.

Expertise is a huge issue when evaluating the board and something that is often overlooked. No doubt investors were relieved to see the track record of Fidelity’s non-executive addition to the China Special Situations Fund.
Before he held his position as a non-executive of the Schroders fund, David Causer held senior roles at a range of well-known companies including managing director of Merrill Lynch Investment Managers until 2001. He was also finance director of Mercury Asset Management and finance director of the British Red Cross Society.

Expertise is not just a question for directors that are joining a board, however. It is equally important for those who have served for several years. For example, are their qualifications still relevant?

The role of an investment trust director has come a long way since the days of long lunches. Today’s directors must be ready to give investment managers a run for their money and stand up for shareholders’ interests. As the role has become so much more demanding, with onerous fiduciary responsibilities, a higher calibre of individual is required.