Devouring of the weak keeps the sector strong

THE health of investment trusts as a whole depends, in part, on mechanisms through which underperforming trusts can be positively restructured for the future or liquidated.

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.

Independent Partners; request a free guide on NISAs from Hargreaves Lansdown

PROMOTED VIDEO
Arts and Entertainment
From Mean Girls to Mamet: Lindsay Lohan
theatre
Sport
Jordan Rossiter celebrates with team mates after scoring the opening goal during the match between Liverpool and Middlesbrough at Anfield
football

Liverpool progress to the last 16 of the Capital One Cup

News
Mike Tyson has led an appalling and sad life, but are we not a country that gives second chances?
peopleFormer boxer 'watched over' crash victim until ambulance arrived
Arts and Entertainment
Geena Davis, founder and chair of the Geena Davis Institute on Gender in Media
tv
News
i100
Travel
travelGallery And yes, it is indoors
Sport
Nathaniel Clyne (No 2) drives home his side's second goal past Arsenal’s David Ospina at the Emirates
footballArsenal 1 Southampton 2: Arsène Wenger pays the price for picking reserve side in Capital One Cup
Life and Style
tech
Arts and Entertainment
The Tiger Who Came To Tea
books
News
i100
Arts and Entertainment
British actor Idris Elba is also a DJ and rapper who played Ibiza last summer
film
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    IT Project manager - Web E-commerce

    £65000 Per Annum Benefits + bonus: Clearwater People Solutions Ltd: If you are...

    Trainee / Experienced Recruitment Consultants

    £20000 - £25000 per annum + OTE £40,000: SThree: SThree are a global FTSE 250 ...

    Trainee Recruitment Consultant - Soho

    £20000 - £25000 per annum + OTE £40000: SThree: As a Recruitment Consultant, y...

    Trainee Recruitment Consultants - Banking & Finance

    £20000 - £25000 per annum + OTE £40,000: SThree: SThree Group have been well e...

    Day In a Page

    Syria air strikes: ‘Peace President’ Obama had to take stronger action against Isis after beheadings

    Robert Fisk on Syria air strikes

    ‘Peace President’ Obama had to take stronger action against Isis after beheadings
    Will Lindsay Lohan's West End debut be a turnaround moment for her career?

    Lindsay Lohan's West End debut

    Will this be a turnaround moment for her career?
    'The Crocodile Under the Bed': Judith Kerr's follow-up to 'The Tiger Who Came to Tea'

    The follow-up to 'The Tiger Who Came to Tea'

    Judith Kerr on what inspired her latest animal intruder - 'The Crocodile Under the Bed' - which has taken 46 years to get into print
    BBC Television Centre: A nostalgic wander through the sets, studios and ghosts of programmes past

    BBC Television Centre

    A nostalgic wander through the sets, studios and ghosts of programmes past
    Lonesome George: Custody battle in Galapagos over tortoise remains

    My George!

    Custody battle in Galapagos over tortoise remains
    10 best rucksacks for backpackers

    Pack up your troubles: 10 best rucksacks for backpackers

    Off on an intrepid trip? Experts from student trip specialists Real Gap and Quest Overseas recommend luggage for travellers on the move
    Secret politics of the weekly shop

    The politics of the weekly shop

    New app reveals political leanings of food companies
    Beam me up, Scottie!

    Beam me up, Scottie!

    Celebrity Trekkies from Alex Salmond to Barack Obama
    Beware Wet Paint: The ICA's latest ambitious exhibition

    Beware Wet Paint

    The ICA's latest ambitious exhibition
    Pink Floyd have produced some of rock's greatest ever album covers

    Pink Floyd have produced some of rock's greatest ever album covers

    Can 'The Endless River' carry on the tradition?
    Sanctuary for the suicidal

    Sanctuary for the suicidal

    One mother's story of how London charity Maytree helped her son with his depression
    A roller-coaster tale from the 'voice of a generation'

    Not That Kind of Girl:

    A roller-coaster tale from 'voice of a generation' Lena Dunham
    London is not bedlam or a cradle of vice. In fact it, as much as anywhere, deserves independence

    London is not bedlam or a cradle of vice

    In fact it, as much as anywhere, deserves independence
    Vivienne Westwood 'didn’t want' relationship with Malcolm McLaren

    Vivienne Westwood 'didn’t want' relationship with McLaren

    Designer 'felt pressured' into going out with Sex Pistols manager
    Jourdan Dunn: Model mother

    Model mother

    Jordan Dunn became one of the best-paid models in the world