I have served my time as an investment trust director. My experience of the inner workings of a trust board has been from the inside, as well as that of an observer from the world of investment. And most revealing my time as a director was too. We, as a board, not only had to deal with the day-to-day issues that being a director of a publicly listed company entailed, we also had to cope with being the object of a corporate raid and, subsequently, a takeover approach. It is at times like this that the trust board director earns his or her fee.

The existence of an independent board of directors has long been cited as one of the advantages that investment trusts enjoy over open-ended funds such as unit trusts or OEICs. Certainly, they offer a degree of independence of approach that is simply unavailable to the bulk of funds open to retail investors.

The ability to place the investment management contract out to tender, or even to sack the incumbent manager, is a defining advantage for investment trusts. It is a check and balance that all investors should value.

Shareholders’ interests

An investment trust is, after all, a company that is owned by its shareholders and that seeks to deliver returns according to the particular mandate it follows. The role of the board is to ensure that this mandate is observed to the ultimate benefit and expectations of the owners and to deal with any other matters of corporate life that develop during their stewardship. In that regard, being a director of an investment trust is no different to serving on the board of any listed commercial enterprise.

Observing corporate governance, dealing with listing issues, coping with unwanted predatory approaches – all are part and parcel of the role, even if it is the monitoring of the investment manager that is seen to be the core function. But, in the end, the defining role of the investment trust director is ensuring that the interests of the shareholders are best served. Little wonder, then, that many trusts expect their directors to own shares, perhaps even having a qualifying stake, as a prerequisite to joining the board.

And anyone who believes that being a director of an investment trust is a soft option should look at what has been going on in this sector over recent years. The split-capital problems in particular have thrown into focus just what is expected of directors. Baillie Gifford’s Robert O’Riordan, who serves as the principal point of contact with the directors of the trusts they manage, points to the fact that board papers have become more comprehensive and weightier as a consequence of recent problems faced by the sector.

Greater transparency

Inevitably, problems tend to highlight potential shortcomings in best practice. In the case of investment trust boards, it was the potentially cosy relationship enjoyed between managers and the directors of the companies they looked after. More perceived than real, the concern was that trust boards operated in a club-like atmosphere – a Masonic network of old school ties and connected characters. If the splits scandal achieved anything it was the realisation that transparency is necessary in all aspects of running an investment trust.

Certainly, the Association of Investment Companies (AIC) – the trade body that represents by far the greater bulk of investment trusts – took action to reinforce the image of its members. Among the initiatives they took forward was a recommendation that directors should serve only nine years in office before coming under annual scrutiny as to their suitability for reappointment. Indeed, as Daniel Godfrey, director general of the AIC remarked, being re-elected should not be an automatic procedure. The value and potential contribution of each director should be reassessed on a regular basis.

Measures such as these should ensure that investment trust boards comprise the best talent that is available to the industry and should certainly dispel any view that being a trust director is in any way a sinecure. Their role does, after all, distinguish investment trusts from the myriad other investment products available to the private investor. They are there so that shareholders can contact them if they have concerns over how a trust is run or how it is performing. They are not there to rubber stamp the actions of the manager.

On the front foot

That boards have developed a more independent approach to the way in which they operate is clear from recent corporate activity. The extent to which boards are prepared to replace the incumbent manager is unprecedented. Managers have been learning the hard way that they do not own the trusts over which they exercise powers of investment. Sometimes a move of manager is nothing more than the board choosing to follow a trusted stockpicker to pastures new.

But it might just as easily be a vote of no confidence in a house that has failed to maintain its performance.

The relationship between the manager and the board, while necessarily arm’s length, can add value to the investment process. Good managers will encourage a dialogue with the board to ensure they get the best out of the relationship they enjoy. And a good board will be proactive – though not prescriptive – in its dealings with the management house. With many investment trust boards made up of those with direct experience of managing money, or with an understanding of how businesses work gained by hands-on involvement in industry, ignoring the contribution a board can make is a short-sighted approach.

Baillie Gifford’s Robert O’Riordan points to the wide variety of non-executive directors that sit on the boards of trusts they manage. Retired diplomats, businessmen who served on the boards of FTSE 100 companies, economists, politicians and senior professional investment managers – you will find all manner of men and women on these boards. And with eight trusts valued at more than £8 billion in total, Baillie Gifford (which is the third-largest trust manager) will be representative of the industry as a whole.

Getting the right mix

And the chemistry of the board is important, too. This does, of course, apply to any business, but how board members operate together can make all the difference when coping with corporate events or ensuring that a difficult period is dealt with in the most suitable manner. My own experience was interesting in this regard. A division of opinion at board level over an important issue meant that even now I cannot be certain we achieved the best result possible. Nor will I ever know.

But if boards need to be more independent and more mindful of the pitfalls that surround anyone in such an important and responsible position, the fact remains that investment trust boards work best when they are in harmony with the managers looking after the funds for which they are ultimately responsible. Corporate action or manager uncertainty adds nothing to the smooth running of a trust. In the end, the ability to concentrate on ensuring the manager is delivering to expectations alone should be sufficient to keep any investment trust board fully occupied and earning their keep.

Pivotal role

So, being an investment trust board member is both an important role in the corporate sense and a crucial part of what separates these closed-ended investment vehicles from their more numerous and heavily marketed open-ended competitor funds. Whether it is monitoring the manager and ensuring the execution of the mandate, dealing with the requirements of a publicly listed company or acting in the best interests of shareholders in the event of corporate activity, the role is full and essential – and pretty much unique in the context of collective investments available to private investors.

In the many years I have worked with the AIC, pointing out to private investors that the existence of an independent board is a positive benefit has become second nature. It ranks alongside discounts, gearing and cheaper management costs as a differentiating factor for investment trusts over unit trusts. The work of a director has become more demanding over recent years. As well as the greater scrutiny now taking place, in part a consequence of the split-capital crisis, investment management itself has become a more complex, professional and competitive business. Directors of these trusts sit in the glare of the publicly quoted sector, with the additional burden of operating in a heavily regulated industry. Shareholders should be grateful for their diligence and involvement.

This article is from the July 2007 issue of What Investment.