Devouring of the weak keeps the sector strong
Sunday 22 October 1995
There are more than 300 UK investment trusts and a further 50 or so investment trust-type funds on the UK stock market. Since the beginning of 1993, more than 80 investment trusts have been launched and only a handful wound up through takeovers. But this "cannibalism" performs a useful function. It eliminates investment vehicles with records too poor to justify survival, and forces change on those whose capital structure or investment specialisation is no longer relevant or has been overtaken by events.
Without this mechanism, long-term confidence in investment trusts could be undermined and their generally good performance record (one of their compelling attractions) threatened.
Nevertheless, predatory action can be destructive to shareholders' interests if certain principles are not observed. These are that all shareholders in a target fund are treated equally and that a cash alternative is provided - as close as possible to asset value - before any change of control is accepted. If the primary purpose of a hostile move is simply to add to funds under management for the aggressor, it is less likely to win support than one with a clear aim to deliver value to shareholders in the target trust.
Aggressive bids, including those for Edinburgh and Dundee, Murray Growth, British Investment Trust, TR Industrial and General and Globe in the 1980s, have also played a role in cutting the average UK investment trust discount from 30 per cent in 1980 (having peaked at 45 per cent in 1974) to the current level of around 7 per cent. Predatory action has played an important part in providing motivation for management groups and trust boards to support the highly successful campaign, orchestrated by the Association of Investment Trust Companies, to rekindle the enthusiasm of the small investor for trusts.
If takeovers are "a good thing", why have there not been more, particularly as many commentators on the trust sector said that 1995 was the year when hostile activity would return with a vengeance, and when there has certainly been no shortage of suitable targets deserving a swift end?
Inevitably, the realities are a little more complicated. In many cases, institutional investors (pension funds, life and assurance companies and so on) would be happy to support hostile actions but are unwilling to cast the first stone. The stockbrokers are even less likely to precipitate, or even support, hostile actions, where they might antagonise the trusts's managers (who are also their clients) and so jeopardise their broking commissions and relationships.
Furthermore, institutions form the bulk of investment trust investors - with a stake in the sector of around 60 per cent. Many of these institutions have held stakes in trusts for many years and are locked in with large potential capital gains tax liabilities. The potential tax liability for many institutions could range from 7.5 per cent of the current price to as much as 15 per cent. So the potential uplift from a cash bid for a trust on a discount of around 10 per cent could be more than offset by the CGT liability. Without a reform of CGT, cash bids for trusts on discounts prior to the bid of less than 15 per cent look unlikely.
Both the Government and the Labour Party have championed changing the CGT regime. BZW's view is that such changes to CGT could lead to a new wave of restructuring among investment trusts.
Although the effect on the trust world of any changes is hardly likely to be at the forefront of public policy considerations, the impact could be dramatic, with as much as 20 per cent of the sector (or nearly pounds 2bn) being reorganised, restructured or liquidated.
But even without CGT changes, out-of-favour specialist trusts trading on significantly wider than average discounts will again create opportunities for predators.
We would argue that such activity is natural and has the function of providing a limit to how wide discounts can go.
Investors should scrutinise predatory proposals carefully to ensure that they operate to the benefit of all shareholders, that costs are fairly allocated, and that suitable cash alternatives are available whenever possible.
But above all, do not buy trusts simply because you think they might be wound up or simply because the discount is wide. It is the quality of the managers and the assets of the trust that will drive the long-term performance.
q The authors are investment trust analysts at BZW.
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