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News Analysis: Struggle begins for future of trusts

Electra bid row has crystallised divisions in industry which City regards as needing radical overhaul
WHEN THE 37-year-old head of an industry trade association suggests in print that a company in his own industry, and a member of the association to boot, "caused its own downfall", then it's not surprising that the 66-year-old chairman of the company concerned should react angrily.

Michael Stoddart, chairman of Electra Investment Trust, says he is "furious" with Daniel Godfrey after the youthful director general of the Association of Investment Trust Companies (AITC) was quoted in the Financial Times as blaming Electra for "failing to market themselves to private investors, which is why they are now in this situation".

He says of the article: "Mr Godfrey has caused me a huge amount of embarrassment by saying it was our own fault."

"I was meant to have retired last Wednesday," Mr Stoddart says, adding that he is reluctant to hand over to his successor Brian Williamson, chairman of Liffe, while the present row rumbles on.

Although the Electra chairman insists that "I'm not having a battle with the AITC," the damage has been done. The row has crystallised the divisions in an industry which many regard as at best needing radical overhaul and at worst an anachronistic hangover from Empire.

The "situation" which the deliberately provocative Mr Godfrey was referring to is 3i's hostile bid for Electra at 705p a share, valuing it at pounds 1.2bn.

Last Wednesday Electra's board rejected the bid and as an alternative launched a buyback of 40 per cent of its shares at approximately its current net asset value (NAV). The trust would then be wound up over the next five years.

The reason that investment trusts have become so unpopular in the Square Mile is that their shares seem to trade at an ever bigger discount to NAV as the years go by.

In 1994 the average discount for UK investment trusts stood at around 3 per cent. This has ballooned to 16 per cent today, provoking people like Mr Godfrey to urge radical action.

The young Turk of the AITC declares: "There are two main solutions: giving shareholders their money back, through a buy-back or restructuring, or finding new buyers for investment trusts."

There is at least one thing Mr Godfrey and Mr Stoddart do agree on; how investment trusts have come to this pass. As Mr Stoddart puts it: "Investment trusts grew up in the early part of the 20th century, when institutions were a lot smaller than they are today.

"They wouldn't have, say, their own operations in North America or Japan. In those days investment trusts saved institutions from having their own overseas departments.

"Now institutions are bigger and they do their own investing around the world. So they don''t need investment trusts in the same way."

Investment trusts have the added bonus of giving retail investors a route into venture capital, which they wouldn't have otherwise, Mr Stoddart adds.

Mr Godfrey and Mr Stoddart are also at one in complaining that many institutions are unsupportive shareholders. "They only stay in because they are trapped by the big discounts and capital gains tax liabilities," says Mr Godfrey. As soon as the discounts narrow they sell out - sending discounts back up again.

There are a few exceptions to this rule. Fleming, where Mr Godfrey used to be marketing director, has launched the Fleming Claverhouse trust for retail investors, which actually trades at a premium at the moment - 0.89 per cent.

Part of Mr Godfrey's solution for the pounds 61bn investment trust industry is to shift between pounds 7.5bn and pounds 20bn of stock from institutional shareholders to retail investors over the next few years.

"Too many institutional shareholders are not there for the long term," he says. "They just feel trapped by discounts and capital gains."

Such a move would have a big impact on Electra, where institutions represent 85 per cent of all shareholders.

Mr Stoddart is sensitive to the charge that Electra hasn't done enough to encourage the small investor. "We have just started a savings scheme," he says, a trend which has taken off in recent years (see chart) but which Mr Godfrey believes still has a long way to go.

As is the way of things, Mr Godfrey reacted to the "caused own downfall" headline by writing a letter to the Financial Times saying that he never said such a thing. He also denies that his remarks were comments on a bid battle.

He was merely responding to comments by Mr Stoddart on the investment industry as a whole, he said.

And Mr Stoddart also protested that he hadn't said that the "whole investment trust industry was under siege", only that "some" parts were.

Not everyone is gloomy about the outlook. Philip Middleton, a top-rated investment trust analyst at Merrill Lynch, is upbeat about prospects for the sector.

Mr Middleton thinks that share buybacks will continue until discounts narrow, and notes that Scottish Eastern has recently proposed to hand back pounds 1bn to investors.

Mr Middleton says: "The advent of LISAs (Lifetime Individual Savings Accounts) could well be good news for the sector. This has the potential to provide a ready-made answer to the sector's search for a mass-market pensions product."

Mr Middleton adds: "Overall, value remains good...whilst recent interest rate cuts will boost demand."

Meanwhile, Mr Stoddart remains robust in his defence of Electra. "We floated 23 years ago this month, at the equivalent of 29p a share, and now we're trading at 685p, which isn't a bad rate of return. We are totally dedicated to shareholder value."

Whether this represents an epitaph or a brave new beginning will depend both on the industry's willingness to change and the City's patience while it does so.