Mepit saga signals lack of faith in investment trusts

News Analysis: Beleaguered sector faces a new threat to survival
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THE much-criticised investment trust industry faced a renewed threat to its long-term survival yesterday when one of the country's biggest trusts said it would hold a vote on dissolving itself next month.

The announcement came from Mercury European Privatisation Investment Trust (Mepit), a pounds 1bn investment fund run by Mercury Asset Management (MAM), after it emerged that US arbitrageurs had put a motion to force a vote on winding up the trust.

Elliott Associates, a US fund manager, has in recent weeks built a 4 per cent stake in the group. The activity was noticed by two already disgruntled shareholders, Scottish Eastern and Advance UK - both investment trusts themselves - which hold just over 1 per cent. Unhappy with the trust's performance, the two approached Elliott earlier this month and concocted the plan to wind Mepit up.

Their case is strong. In the year to April, MAM's managers provided a return of minus 2.1 per cent. The trust's stated aim was to match a benchmark which returned plus 8.5 per cent.

Shares in Mepit have been trading at a 10 per cent discount to the value of the investments held by the trust, preventing dissatisfied investors from selling their holdings for their full worth. Yesterday they rose 2p in a falling market to close at 165.5p.

In the past five years Mepit had attracted over 34,000 retail shareholders with its promise of lucrative opportunities stemming from European privatisations.

But MAM's fund managers discovered that obtaining enough shares in privatised companies was harder than had been thought. In the past two years investors have become dissatisfied, claiming that the group failed to take advantage of the flotations of Swiss Com and Telecom Italia, instead investing 15 per cent in eastern Europe at just the wrong moment last year. Another complaint is that one of the largest holdings was in aero-engine maker Rolls-Royce - hardly a continental privatisation.

Some investors privately remark that in spite of this, Mercury is paid around pounds 10m to manage the giant trust. And some question the willingness of the board of the trust to consider looking for another investment manager - Peter Stormonth Darling, chairman of Mepit, is a former director of MAM.

The motion put by the rebel shareholders has a familiar ring to it. It calls on the board of Mepit to offer investors the chance to cash in their assets immediately and at 100 per cent of their value - either as cash or as units of shares.

Mepit has promised it will change its investment mandate and is in the midst of plans to buy back 15 per cent of its shares and turn itself into a generalised European trust. But it has set its face against Elliott's demands.

Yesterday the situation began to turn hostile. In a statement, Peter Stormonth Darling said: "The board believes that the recently announced moves to broaden the company's investment mandate, together with the other proposed changes, are already designed to add long-term shareholder value." A spokesman for the trust was more explicit. "This is all about a quick gain. What you have here is basically a carpetbagger who has come in very recently and wants to make a quick buck."

The war of words recalls a similar fight three years ago. This time it was not Mepit but Kepit - Kleinwort Benson's version of the same vehicle based on the same European privatisations. In 1996 Kepit came under heavy pressure from institutional shareholders who complained about the trust's performance and management. It was later forced to wind up.

Last year another pounds 1bn trust, Scottish Eastern, was put under pressure by shareholders and forced to reconstruct itself. Elliott was also involved in separate moves to force a change at Dunedin Worldwide

At the centre of all the shareholder complaints is the issue of discounts. Shares in the average investment trust typically trade for substantially less than the value of the net assets per share held by the trust. Buy shares in the average investment trust, and they sell for an average of 14 per cent less than the value of the investments.

The size of the discount is a sign not only of the market's lack of confidence in the trust's management; it also makes an investment trust holding much less liquid in comparison with a unit trust, the alternative and rival investment.

Daniel Godfrey, the young chairman of the Association of Investment Trust Companies, is struggling to shake off the industry's old-fashioned image. He believes the fundamental problem is not with the trusts themselves, but their marketing.

"The underlying problems are the over-representation of institutions on shareholder registers, which has led to volatility in discounts, and the comparative failure of the sector to take its share of the retail investment boom."

Institutional investors once relied upon investment trusts for global fund management expertise. Now, believing they have capacity to do their research themselves, the attraction has gone. Only the discount remains.

Mr Godfrey believes the solution lies with retail investors. He has announced a pounds 27.5m plan to boost the industry's image, both with the public and the independent financial advisers who sell the products. If enough money is raised from the trusts themselves, a TV, radio and press campaign will start in the autumn.

The campaign will strive to awaken retail investors to the virtues of investment trusts, now available as part of an Individual Savings Account (ISA). Investment trusts very narrowly outperform their rivals in unit trusts in the longer term (see table). They can also cost less: charges for managing the money rarely outstrip those of unit trusts.

Crossing his fingers for luck, Mr Godfrey hopes the autumn could see "a turning point in the fortunes of the industry".