ESG is the dominant topic amongst investors currently, with environment and social aspects particularly widely discussed. Governance has received less emphasis; yet it is vital for the long-term interests of investors and for wider society. We have for many years engaged with boards of trusts where corporate governance has been weak but until recently our approach has been to hold private discussions rather than to use public letters and headlines in the press. It is easier for people to improve their behaviour if it looks as though it is their own idea.
In general, we have focused on specific failures of governance. In one recent example the directors of a liquidating trust tried to repay preference shareholders, including our clients, less than their entitlement. Surprisingly this attempt was supported by those directors whose explicit role was to protect preference shareholders. It also transpired that the Chairman of the trust had negotiated a personal bonus scheme linked to the profit made by a prominent hedge fund who had built up a position in the company. Rather than seeking to impartially balance the interests of competing stakeholders, the Chairman partnered with a single shareholder and had more concern for his own financial reward. We mounted a robust legal defence and achieved a satisfactory result, without a public intervention.
There are cases when a more public intervention is useful. Recently we wrote a public letter in support of the board of the trust Gabelli Value Plus. This trust has had a poor record since its listing in 2015 and remains sub scale and illiquid. Both the board and a significant independent shareholder have publicly stated that the trust should discontinue. The concern is that the largest shareholder, Associated Capital Group (“ACG”), has a 27.9% stake and is closely associated with the investment manager. So close in fact that ACG was only recently spun out of the investment manager and both companies share the same Chairman, Mario Gabelli. There are some concerns that ACG could use its voting block to seek to continue the trust for the benefit of the manager and against the interests of minority shareholders and the recommendation of the board.
This makes for a particularly interesting case as directors are trying to act in shareholder’s interests but may be blocked by a significant stake held by a close associate of the manager. It is widely believed that a manager with “skin in the game” is an attractive feature in a trust. At the asset level there is evidence that the returns are positively affected. What is more problematic is the impact on corporate governance of stakes, or archaic voting structures, that give control to one shareholder. Those trusts with the largest and most persistent discounts are almost all controlled. In an ideal world, control would not matter because the independent directors would ensure that minority shareholders would not be disadvantaged. In practice, all too frequently we see directors fail to stand up to dominant managers; it is uncomfortable to do so and success relies on marshalling disbursed and often apathetic shareholders against the manager’s voting bloc. We hope that GVP will be an example of independent directors successfully protecting minority shareholder’s interests, and that directors of other controlled trusts will take note.
Most of our interventions in private have been to remind directors of commitments that they have made but not kept, usually for reasons that are quite unconvincing. In future we would hope that corporate developments will be more positive and aimed at growing trusts. The motivation for boards to act is supported by the realisation that at least half of all trusts, by number, have lost their raison d’etre. The purpose of an investment trust is to provide an efficient vehicle for the savings of individuals and small institutional investors, often intermediated by wealth managers and IFAs. Sadly, changes in the regulatory regime and consolidation amongst wealth managers means that small illiquid trusts can no longer fulfil this role. The definition of a small trust is controversial, but a good case can be made for a threshold of around £500m for anything other than very specialised investment trusts. Pressure is at last starting to grow from investors. Brokers too are reluctant to take on trusts with no viability and no plan. That could prove to be a powerful influence.
With so many trusts that need restructuring, no doubt reform will take several different forms, including mergers, rollovers into larger trusts or open-ended funds and simple liquidation. We hope that many with liquid underlying portfolios will adopt the more constructive approach of transitioning to a Zero Discount Model (“ZDM”). Under this model, pioneered by Personal Assets Trust plc in the 1990’s, the trust buys back or issues shares to ensure that the net asset value per share and share price do not meaningfully diverge. The great advantages of a ZDM is that, if properly implemented, it transforms the liquidity of investment trusts as well as removing discount risk. It does so whilst maintaining the advantages that investment trusts have over open-ended funds, namely independent boards and the power to gear modestly. Another key plus is that it allows even a small trust the chance to grow to a relevant size. Of course, if shareholders do not rate the manager, it can also shrink. However, if the starting position is an investment trust that shareholders no longer value then shrinking and ultimately restructuring is the best path forward.
History suggests that where the management is sound and the strategy meets the needs of investors, the potential reward for aligning the structure of a trust with shareholders’ interests is much greater size. After all, a ZDM allied to NAV growth per share has seen Capital Gearing Trust grow, since 1982, from a market capitalisation of c. £0.5m to over £500m.
Further reading: Investing in the social part of ESG is a good place to start