Secrets Of Success: A canny lot, those Scottish investors
Saturday 25 March 2006
Being in Edinburgh this week proved a happy choice, as the main talking point was the proposed merger between the two Alliance trusts of Dundee - and there's nothing investment traditionalists north of the border like better than dissecting the merits of the latest investment trust news.
Down South, investment trusts may be seen as poor relations in the fund world, but diehard value-investors, among whom I am happy to count myself, have long known that a really good investment trust is the ideal building-block for a long-term portfolio - just as an indifferent investment trust (of which there have always been a good number) tends to leave you disappointed.
There is no question that the Alliance Trust merger (if it goes through, as it looks likely to), is big news in the investment trust world. Combining these two longstanding trusts will create a company with an asset base of some £2.7bn. This will catapult it above Foreign & Colonial, the even older global generalist trust, with which the Alliance trusts have long competed in investors' eyes. Only 3i will have a larger market capitalisation among investment trusts.
Whereas F&C can date its origins to 1868, the two Alliance trusts were originally established in the 1880s, to provide overseas investment opportunities for wealthy Scottish investors of the day (nothing modern about emerging markets as an asset class).
The original Alliance Trust lent money to growing businesses, mainly in the Pacific North-west of the US, while Second Alliance, which followed five years later, was set up to grow a mortgage business based in Hawaii (hence its first name, the Western and Hawaiian Investment Company).
The two have been twins since 1918, when the companies decided to operate out of the same offices, sharing management and administration costs (an early example of the parsimony with which Dundonians like to manage their money).
While their portfolios differed for many years, in the last decade they have gradually been harmonised, to the point that they are more or less identical (mortgages have long since given way to global equities as the mainstay of the portfolio). The shareholder lists are now in fact the only real difference of any consequence between the two trusts.
Given this, the decision to merge would seem to pass the bleedin' obvious test, to the extent that most people wonder why it has taken 88 years - combining two portfolios run by the same management team, with the same board of directors, investing in exactly the same securities, is something of a no-brainer. The boards estimate the merger will save £250,000 a year in shared costs.
So, end of story? Not quite. Canny investment trust followers, of whom Edinburgh boasts many, have not got where they are without learning to pore over small print. The unanimous view I heard was that the fees the two trusts will incur in completing the merger look shockingly high at £4.5m. According to Alan Harden, the American chief executive who's gradually been changing the way things are done at Alliance since taking the helm in Dundee two years ago, the fees are insignificant - just 0.16 per cent of the trusts' combined assets.
To an investment banker, fees on this scale are indeed trivial, but such casual talk about pounds and pence is anathema to the hardened investment hands I talked to in Edinburgh ("scandalous", said one rival trust manager). Why, wondered another, given that the trusts are virtually identical, do both have to hire an expensive investment bank to give separate advice to an identical board of directors on a no-brainer deal? There seems no question of the directors voting to cut their fees to reflect the halving of the number of meetings they will have to attend.
You could argue that the costs of the proposed merger, however nonsensical, have been more than compensated for already by the rise in the two trusts' share price since the deal was announced. The merger should also remove any lingering doubts about whether the board and chairman can technically be regarded as independent, as required by the London Stock Exchange's Listing Particulars (another arcane issue on which my ear was much bent).
Unsurprisingly, for those who know their Scottish investors, the biggest beef was that the boards were too mean to offer shareholders in the smaller Second Alliance Trust a cash alternative to the merger terms.
As the shares in both trusts have traditionally traded at an above-average discount to asset value, reflecting their unspectacular performance, a cash alternative would allow those who wanted to do so to exit at a better price. (And lightening up on what is largely an equity portfolio might be prudent.)
For the Alliance trusts, allowing shareholders to exit for cash would have the unfortunate effect of raising their ultra-low total expense ratio (currently about 0.34 per cent per annum, the lowest in the sector) to a new higher level. As low cost has always been one of the Alliance's main selling points (and a highly laudable one too), this doubtless looks unattractive to the board, as would shrinking the size of the trust. It may also help explain why the Alliance directors have (until now) steadfastly refused to contemplate using share buybacks to reduce the trusts' discounts, as many other investment trusts have been forced to do.
I have long been a fan of the Alliance trusts, precisely because of their parsimony, so will be watching this with great interest. The message that such a venerable beast is changing is not necessarily for the worse, as traditionalists fear. The question being privately mouthed by my Edinburgh friends is whether the board's meanness regarding a cash alternative will now prompt some hard-nosed arbitrageur to come in and force the board to introduce buybacks and a cash alternative, at least for the Second Alliance Trust, the junior partner in this deal. It seems fanciful, but hopes of a quick windfall are what Edinburgh money-men of my acquaintance dream about at night.
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