Business Analysis: Sleepy world of investment trusts shaken up by Scottish bid battle

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The Independent Online

Tempers have started to fray in the bid battle for Securities Trust of Scotland (STS), the £324m investment trust that is the subject of a rare hostile takeover bid for the sector from its rival Perpetual Income and Growth trust (Pigit).

Tempers have started to fray in the bid battle for Securities Trust of Scotland (STS), the £324m investment trust that is the subject of a rare hostile takeover bid for the sector from its rival Perpetual Income and Growth trust (Pigit).

Sir Patrick Sheehy, the erstwhile chairman of British American Tobacco and now chairman of the Pigit board, attacked STS's rejection of his trust's offer yesterday as "scorched earth with a cynical twist couched in a litany of highly selective statistics".

The STS bid battle is symbolic of more important changes gathering momentum among the boards of directors responsible for running the trusts on behalf of tens of thousands of private investors and hundreds of City institutions.

Sir Patrick's display of verbal pyrotechnics - unusual for a trust chairman - has created rare entertainment in a stock market sector that, while still large, weighing in with a £49.8bn market value, is better known for plodding investment performance and a staid history rooted in the City's Victorian forbears.

Shares in the sector have been constantly trading at a discount to the net asset value of their underlying portfolios, while the recent trauma of split capital trusts has dented the sector's reputation, which hitherto enjoyed an untarnished record for generations. But changes introduced by the Financial Services Authority after the splits scandal have jolted the sector into action, on addressing corporate governance failures and its poor performance record.

The battle for STS is the latest sign of a growing appetite for action among the more forward-thinking trust boards rather than the sector's traditional supine attitude to change.

The board of STS, rather than recommend Pigit's all-share offer, which includes a partial cash alternative, has come up with three options of its own: liquidation of the trust and a return of cash; the chance to roll its STS shareholdings into Lowland, another top performing rival trust; and the offer of rolling its STS shares into a New Securities Trust - a revamped STS run by the same fund management firm, Martin Currie.

Neil Donaldson, the chairman designate of STS, said his board's proposals offered better value, better choice, the option of higher income and the chance to opt for shares in a better-performing trust than Pigit.

Naturally, Sir Patrick and his board remain sceptical and the fight goes on. Analysts at the broker Panmure Gordon reckon the STS rejection is a step backwards for the sector. "One can argue about the finer points of the terms of exit or rollover, but if one supports STS it is a vote for an old-fashioned view of corporate governance and shareholder value that the sector badly needs to leave behind it."

In October 2003 the FSA introduced listing requirements for investment trusts, which are proving a watershed. The rules beefed up disclosure requirements and forced trust boards to justify their choice of fund manager annually. Since then some of the biggest trust names, such as Witan, Foreign & Colonial and Henderson Electric & General, have introduced radical changes to their approach to fund management and capital structures, which have helped narrow discounts and improve investment performance.

The chart shows how discounts to net asset values have started to fall over the past two years, evidence that a new approach to investment trust corporate governance is working.

After a review by its board, F&C announced it would seek external fund managers to handle its exposure to large companies in the US and Japan. Up to one-third of F&C's assets could be run by fund managers outside the trust's traditional management company, F&C Asset Management.

Witan, long seen as an in-house fund of Henderson Global Investors, has made a strike for independence and contracted out its fund management requirements, running itself more like a conventional pension fund with different managers. "These are major developments effecting major savings vehicles for tens of thousands of savers," Robbie Robertson, an analyst at Dresdner Kleinwort Wasserstein, said.

As recently as Tuesday, F&C Pacific Trust announced it would split its investment mandate between Aberdeen Asset Management and Nomura, again leaving behind the incumbent, F&C Asset Management.

One of the best recent examples of this sort of change is Henderson Electrical & General, a darling of the Nineties boom that failed to perform after the three-year bear market. Last year the board handed the investment management contract to Taube Hodson Stonex Partners, a new fund management company formed by the City veteran Nils Taube.

Boards have also been active in other areas, noticeably share buy-backs. Trusts are increasingly adopting so-called "discount protection mechanisms" which boil down to trusts committing to quarterly buy-backs. The theory is that the certain knowledge among shareholders that they can sell at, or near, net asset value should stop a large discount opening up.

Tom Tuite-Dalton, an investment trust analyst at Arbuthnot Securities, said: "There are two trusts that have set the example: Invesco Perpetual European and Gartmore Growth Opportunities."

Hedge funds have been taking more of an interest in investment trusts, particularly in years when stock markets have been flat. Their pressure has helped keep discounts and fund performance under the spotlight.

Not all trusts trade on deep discounts. Long-term top performers such as Anthony Bolton's Fidelity Special Values trust and British Empire Securities have consistently enjoyed share prices at a premium to the net asset values. Determined marketing campaigns and regular savings schemes have also helped maintain demand for shares but in the long run, fund performance is what counts.

Investment trust companies are now hoping they can leave the splits scandal behind and that their relatively modest fees and transparent structures will make them increasingly popular among a population needing to save more.

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