Outlook: Small holders lose out in trust hunt

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The Independent Online
INVESTMENT TRUSTS are hardly yet an endangered species. At The Independent, and in most other national newspapers, more listings of investment trusts are carried than for any other sector. Even so, these usually inoffensive creatures are being hunted as never before. Nor are we talking here about the relatively harmless antics of the countryside alliance. The hunters in this case are arbitrageurs, generally of the overseas variety, and they come armed not with horse and hound but with kalashnikovs and magnums.

The latest investment trust to fall victim to their money making ends is Overseas Investment Trust, a pounds 200m trust managed by Morgan Grenfell Trust Management. Just before Christmas, a group of US based arbs bought into the trust and forced the board to bring forward proposals for unitising its assets. Yesterday the trust's chairman, Richard Heseltine, resigned in disgust, saying he could play no further part in the process. What's going on here?

There's nothing new in what OIT is being subjected to. Nearly all investment trusts trade at a discount to their net asset value. That discount can be eliminated through unitisation. A turn is to be had by forcing the process. How big a turn depends on the size of the discount.

The curious thing about this trust is that it is so small. Normally, arbs target poorly performing trusts which trade at big discounts. But actually OIT hasn't done badly at all in recent years, consistently recording double-digit gains in capital value. The arbs were therefore forced to buy in at a discount of just 9 per cent. By the time liquidation costs are taken into account, they are unlikely to end up with any more than half that - hardly, it might be thought, worth the time value of the investment. Still, if there's a dime to be had, an arb would sell his own grandmother to get it, and since this is the free market, why not?

One reason is that unitisation or liquidation is generally not in the best interests of ordinary, long-term investment trust shareholders. Because investment trusts have independent boards of directors, whose job it is to safeguard the interests of shareholders, their ongoing management costs are generally much lower than a unit trust, whose purpose is that of earning fees for the manager.

Take the example of Kleinwort Benson Overseas Investment Trust, which is also being unitised, again under pressure from arbs. The trust's annual management charge was a half a per cent of the assets. The Save and Prosper unit trust that will replace it will charge one and a quarter per cent. Furthermore, the new unit trust will invest predominantly in investment trusts, in effect doubling up on the cost of asset management. The discount may disappear, but it is not clear this compensates long-term investors for the many countervailing advantages of investment trust status.

There's a wider point too. OIT was established so that British investors could invest overseas - not to enable overseas arbs to invest in Britain, strip out the discount and then ship it back to the Bahamas. There's not obviously anything that can be done about all this, but it's a rum old business all the same.