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Enthusiasts once called investment trusts the City of London’s “best-kept secret”, thanks to their low profile and strong performance.
No longer. These closed-end investment funds still comprise more than a quarter of the FTSE 350. But their recent performance has been poor, as higher interest rates diverted investors into government bonds. That was compounded by 2022 disclosure rules casting an unflattering light on their operating expenses.
Unfairly so, in the view of the industry and some parliamentarians. The rules require funds of funds to report the internal expenses of investment trusts they own on a look-through basis. Critics argue that investment trust share prices should already reflect fees paid out to managers and that the rule means double counting of costs.
This is debatable. But other financial centres do not impose the rules this way. The government has pledged to address this; the FCA plans to consult on a new regime. However, critics want greater urgency.
This is not funds’ only regulatory headache. Recently introduced consumer duty rules, which require companies to consider the best interests of customers, have prompted some platforms to boot off investment trusts. Fidelity, for example, has restricted new investments in companies such as RIT Capital Partners and Abrdn Private Equity Opportunities.
Complexity is another source of disagreement. Hargreaves Lansdown, for example, has restricted investors from buying shares in infrastructure companies such as Digital 9 Infrastructure and Cordiant Digital until they pass a questionnaire showing they have understanding of “complex investments”.
That is reasonable. The investment companies’ own documents suggest the products are intended for knowledgeable or sophisticated investors. Nonetheless there is a risk of mission creep. The Association of Investment Companies is worried about platforms choosing to designate trusts as complex.
Discounts to net asset values have narrowed in anticipation of falling interest rates — from 17 per cent last October to 7 per cent. But that has been flattered by the outperformance of 3i Group. If 3i is excluded, the sector discount has shrunk by just 3 percentage points since October to 16 per cent. The discounts have attracted activists such as hedge fund Elliott Management which are pushing trusts to return capital to investors. Further consolidation, on top of the handful of mergers and liquidations that took place last year, would improve liquidity and cut costs.
If trusts are to fulfil their role as suppliers of permanent capital for infrastructure or the energy transition, the discounts — which have averaged 6.5 per cent over five years — will need to shrink.
Reform of disclosure rules might lure back buyers. But self-help measures will probably matter more.
