Secrets Of Success: Shake-up time for investment trusts

I have never understood why investment trusts are so often described as sleepy and dull. You only have to look at some of the recent exciting events swirling around the Amerindo internet fund - where two founders of the American management company Amerindo have been accused of walking off with large amounts of a client's money, one of them is in prison, the shares are languishing at a huge discount, and investors have been at war over the future of the company - to see that life in the "backwater" of the investment fund world is not always short of incident.

I have never understood why investment trusts are so often described as sleepy and dull. You only have to look at some of the recent exciting events swirling around the Amerindo internet fund - where two founders of the American management company Amerindo have been accused of walking off with large amounts of a client's money, one of them is in prison, the shares are languishing at a huge discount, and investors have been at war over the future of the company - to see that life in the "backwater" of the investment fund world is not always short of incident.

(For those of a nervous disposition, there is no question of anyone having actually walked off with the assets of the investment trust, one of several funds managed on a contract basis by Amerindo.)

Probably few people would describe events in the split-capital sector as being either dull or sleepy (although it is true that one of the most egregious, underperforming split-cap trusts was bizarrely promoted at the height of the mis-selling scandal as being the fund "that lets you sleep at night").

One of the notable features of the past couple of years is the way in which corporate raiders - or arbitrageurs, to give them a more euphemistic name - have started to make their presence felt in the investment trust sector, buying significant shareholdings in poorly performing trusts and putting pressure on the boards of the trusts, either to change the management, or to liquidate and return the assets to shareholders.

This process is causing a lot of angst among some of the more complacent members of this venerable industry. This outbreak of unbridled shareholder activism is having a broadly beneficial effect, just as the activities of Ivan Boesky, Jimmy Goldsmith and the other corporate raiders of the late 1980s did much to force complacent corporate managements to get their act together, for the eventual benefit of shareholders as a class.

Too many investment trusts have been coasting along for too long, earning fees but failing to show any evidence of persistent satisfactory performance.

What is interesting is that the drive to enforce improved performance in mediocre or poorly performing trusts has now reached the heart of the investment trust business, the generalist global trusts, which in some cases have been around for a century or more, and include names with which the industry is most closely associated - such as Foreign & Colonial, the Alliance Trust and the Scottish American Investment Trust.

There is hardly a single investment trust of any size in the sector whose fortunes have not been affected in some way or another by the threat of critical inspection by outsiders intent on forcing change and demanding improved performance.

Henderson, a City firm whose history is intimately associated with the investment trust sector, not so long ago announced that it was to hive off the management of parts of the portfolio of its Witan trust, one of the larger global generalist trusts, to specialist outside managers. Such a move would have been unthinkable even 10 years ago. Foreign & Colonial is doing something similar. In both cases, the board appears to have been reacting to suggestions that for all their glorious history, neither firm has sufficient in-house expertise to manage all the different elements of its global mandate.

The Anglo and Overseas Investment Trust has been forced into a reconstruction by the emergence of arbitrageurs on its share register. Shareholders in the trust are being offered the chance to take cash for their holdings, with the alternative of rolling over their existing shares into a new trust to be managed by the new investment management boutique Edinburgh Partners. This outcome, while not without its costs, gives shareholders the option of either getting out of the fund without a large penalty or locking into what should be superior future performance.

Two other trends are supporting the move towards improved performance in the investment trust sector. One is pressure to improve corporate governance practices. While, in theory, investment trusts, with their allegedly independent boards of directors and direct accountability to shareholders, should be better run than unit trusts, in practice it rarely seems to work out that way.

Too often in the past, boards have effectively been "captured" by the fund management companies which in many cases both set up the trusts in the first place and are then hired to run the investment portfolio.

This is now beginning to change, with the introduction of new independent blood as directors, and more transparency in the relationship between boards and management companies. Boards are also beginning to make a much more serious attempt to manage the discounts to asset value at which many investment trusts have traditionally traded. Investment trusts can now not only buy back their own shares, but hold them in treasury as well, meaning that they can now take a much more active role in reducing or even eliminating discounts.

"For too long now," says Richard Green, a long-time investment trust specialist, writing in a new investment trust newsletter, Investment Trust Scrutineer, "investment trusts have lived relatively comfortable and protected lives behind the defensive barrier of those often wide and volatile discounts." He argues that the volatility introduced by discounts has been a big turn-off for investors.

He wonders whether the boards of investment trusts are still doing enough to encourage new sources of demand. I share his caution. There have been too many false dawns in the past to suggest that all the poor habits of the past have suddenly been eliminated. Yet, investment trusts can still be fertile hunting grounds for discerning investors.

John Newlands, editor of Investment Trust Scrutineer, lists eight trusts he thinks would make suitable core holdings for building an investment portfolio ( www.newslandsfr.co.uk).