Code bites as trusts launch management reviews

These are interesting times for investment trusts. Discounts have reached their tightest levels for 12 years and corporate action is on the rise.

At the end of March, Premier Fund Managers was appointed to run Gartmore Absolute Growth and Income, while Merrill Lynch took over management of the F&C Emerging Markets trust. Investment trust analysts say this is part of a trend that began in 2003.

What is causing the more rapid changing of fund managers? Undoubtedly, it has partly been caused by the introduction of the Combined Code on Corporate Governance in 2003.

This placed formal responsibility on investment trust boards for reviewing the performance of fund managers on at least an annual basis. Boards now have to justify why they are retaining fund managers.

Charles Cade of Close Wins says performance is a key trigger for trusts seeking a new fund manager. “Often it is a gradual development because of underperformance over a long period of time rather than just because it is time for the annual review,” he says.

Cade adds that he would not recommend a trust changes manager after just one year of underperformance.

A change may be required because the fund manager leaves the asset manager that is managing the trust, says Cade. This would normally at least prompt a review of the trust’s management.

Another trigger, he says, has been corporate action among asset management groups. “When DWS was taken over by Aberdeen, for example, this led to the management of the Equity Income trust being transferred to Standard Life,” Cade says. “F&C has lost a couple of trusts, such as Active Capital, since its merger with Isis.”

Dan Kemp, head of fund research at Christows, says one of the drivers has been a more active shareholder base. “This is partly because of the behaviour of arbitrageurs but it is also long investors seeking to maximise their returns from trusts,” he adds. “There are fewer investors now who buy and hold investment trusts for the long term.”

Nick Greenwood, chief investment officer of iimia, agrees, saying that one of the ways a trust can withstand shareholder pressure and avoid a winding up by arbitrageurs is to change the fund manager. Indeed, this is part of the trend of trust directors trying to take a more proactive approach.

Some directors see the changing of managers as a form of discount control. Paul Craig, a fund manager at New Star, says this more proactive approach is partly attributable to the split-capital investment trust debacle. Directors have learned lessons about the need to monitor fund manager performance more closely.

“Nick Brind, manager of the New Star Financial Opportunities trust, for example, held one stock whose share price fell quite sharply in a day,” says Craig. “The directors phoned to check what had happened. Proactive behaviour of directors is more apparent than in the past.”

Finally, there is peer pressure. When some trusts start to change managers, it encourages others to do likewise.

Is changing the fund manager proving successful? Greenwood says it is too early to judge as the more active switching has only been taking place since 2003. He warns, however, that if they do not prove successful then the pressure will mount for trusts to be wound up.

Nevertheless, Greenwood says there are hopeful signs. “F&C recently lost the team managing the Emerging Markets trust,” he says. “The board has transferred the management to Merrill Lynch, which has a strong Latin American team, so that looks a good move.”

Greenwood gives the Edinburgh Worldwide trust as an example of a “spectacular success” of the fund manager being changed. In November 2003, the management switched from Edinburgh Fund Managers to Baillie Gifford.

Kemp says a change in fund manager can present an investment opportunity through the narrowing of discounts. “This is not usually immediate as it takes a while for information to spread around investment trust investors. But often the discount will narrow,” he says.

He gives the transfer of the management of DWS Equity Income trust to Standard Life as an example. “The management of the trust has been taken over by Karen Robertson, who is well regarded as an open-ended manager,” Kemp says.

“The discount did not close immediately on Standard Life taking over the trust but as investors picked up on the move, the discount has narrowed.” The trust is now trading on a 6.6% discount.”

Cade cautions, however, that the environment has been favourable to investment trusts over the past three years. There has been strong stock market performance and discounts have been narrowing.

Nevertheless, he adds that the more pro-active behaviour by directors has led to some fund management groups putting more resources into their marketing and the management of trusts. “In the past, some groups viewed investment trusts as a bit of a cash cow,” he says. “But now they feel more pressure to perform.”

Another development has been trusts changing their mandates. Cade says this is not being done by trusts in out-of-favour sectors. “In 2000, for example, some trusts converted their mandate to become technology funds and then suffered in the subsequent downturn,” he says.

Kemp says mandates are being altered because some are not appropriate for the current investment environment and, therefore, it makes sense to change them.

“This is also part of a move by directors to try to boost demand for investment trusts by differentiating them from unit trusts,” he says.

Craig notes there has been a move to specialised mandates and more illiquid underlying asset classes, such as small caps, than are offered by unit trusts. He adds that a change of manager can lead to a new investment approach even without a formal change in mandate. “Investors need to be aware of the possibility of a new investment approach being adopted,” he says.

One trust to change was when Henderson lost the management of the Electric and General trust to Taube Hodson Stonex. “This is still a global fund but it has a quite different investment style. The discount has narrowed to 6%,” Craig says.