Regulatory regime relief
In recent years the investment trust sector has endured a perfect storm not of its making. Investors have suffered as discounts have widened. Yet, when investing, the long sweep of time throws up key turning points which are often sparked by catalysts which are least expected. There are reasons to believe the worst may now be behind us – sunnier uplands beckon. As such, patient investors should reap the rewards of what will be a meaningful, if nuanced, period of outperformance courtesy in large part to discounts narrowing as markets continue to climb the wall of worry.
Crisis and opportunity
It has been hard pounding. An overly burdensome regulatory framework regarding cost disclosure, a consolidation of the wealth management industry looking to invest in larger, more marketable companies at the cost of their smaller brethren, difficult economic and geo-political events, heightened discount volatility shaking the confidence of some sector investors, combined with higher interest and discount rates bringing into question the validity of certain valuations, are just some of the reasons the going has been tough.
Such times have seen discounts fall to their widest level since the global financial crisis of 2008. And while there has been some recovery, they remain at elevated levels with little sign of respite. Markets alone have not been able to lift the gloom. This year to 30 September has seen the MSCI World (£) index rise 12.96%, the FTSE All-Share index 9.85% while the sector’s FTSE All-Share Closed-Ended index has managed a total return of just 6.34%. This is despite companies performing well in Net Asset Value (NAV) terms and those with income-focused remits again not disappointing. Yet a catalyst for a gradual rerating may be on hand.
Welcome news that the Government and Financial Conduct Authority (FCA) are replacing the EU-inherited consumer disclosure regulations (PRIIPS) with a framework better suited to UK markets has been well received. As such, investment trusts will be removed from the scope of the PRIIPS regime and a new Consumer Composite Investments (CCI) regime introduced after an FCA consultation. In the meantime, ‘regulatory forbearance’ is being applied so these companies need not follow the PRIIPS requirements.
This brings immediate relief as companies will no longer be required to publish Key Information Documents (KID), which completely misled investors about risk, costs and projected returns. Furthermore, companies will no longer have to roll up their corporate costs with their managers’ charges (and so double count) when disclosing a cost figure – a figure which has been unduly high in cases, depending on the assets being managed. In fact, a ‘zero’ can be declared, which better reflects the fact share prices already recognise costs have been absorbed within NAVs. Both issues have been covered in previous columns.
This double counting of costs has erroneously made investment trusts look expensive. Given an incorrect industry emphasis on cost disclosure rather than performance net of fees, these companies have been increasingly shunned by institutional investors, IFAs, wealth managers, platforms providers and private investors alike. And widening discounts have meant new private investment in vital sectors such as renewable energy and infrastructure assets has almost dried up entirely, while share buybacks and tender offers by companies attempting to narrow their discounts has further negated sector investment – not a happy combination.
Together with many other City and company names, the Capital Markets Industry Taskforce has described the discarding of the PRIIPs regime as a “quick and easy win” for the UK. The Treasury and FCA, the cost disclosure campaign group including sector specialists, the LSE and parliamentarians, have all contributed to this positive development. It has been a pleasure to be part of the campaign, even if it was frustrating at times! But the job is not yet finished. A consultation on the new CCI regime involving stakeholders will precede its introduction during the first half of next year. It is important this opportunity is seized.
The LSE submitted earlier this year a letter in response to Treasury guidance on CCI signed by more than 300 signatories, and this gave a strong steer as to what was required. The cost disclosure campaign group has proposed a simple ‘Statement of Operating Expenses’ (SOE), which would highlight company expenses from their Report & Accounts in a clear way to provide a more accurate assessment and aid consumer understanding. All stakeholders are encouraged to support it. One hopes those investment houses with large unit trust operations, where costs can be higher, are not conflicted.
Other considerations
Of course, one swallow does not make a Summer. The sector faces other headwinds. The demand of wealth managers’ core lists for companies to upscale at the risk of exclusion is one. Yet this underestimates the real possibility that retail investors will still support those smaller-sized companies possessing good track records and specialisms offering good prospects. Bigger is not always better.
Meanwhile, previous columns have highlighted why higher discount rates questioning the validity of certain NAVs in the infrastructure and renewable energy sectors is an opportunity for the investor. A focus on what is real and realisations at premiums to carry value bode well as interest and discount rates edge down. High correlations between inflation and company revenues also support healthy dividends.
And while the macro-economic news and geo-political tensions will rumble on, having proved its worth over a proud 150-year history, perspective suggests the sector will continue to perform well over time. Without being complacent, and while recognising volatility, it has always evolved in response to global uncertainties and opportunities, and most importantly to investors’ needs. There is no reason why it will be different this time.
As for the heighted discount volatility leading some investors to question future investment, a better and more transparent regulatory regime which aids understanding should encourage predictability and long-term investment generally across the sector. It is certainly in the Government’s interest to see this through given its commitment to increase private investment in priority sectors such as infrastructure. The mood music is changing.
Sound companies previously disclosing higher costs and sitting on wide discounts should particularly benefit over time. Portfolio holdings such as The Renewables Infrastructure Group (TRIG), Foresight Environmental Infrastructure (FGEN), HICL Infrastructure Company (HICL), and International Public Partnerships (INPP). As do our private equity holdings including Patria Private Equity Trust (PPET), Pantheon International (PIN), CT Private Equity Trust (CTPE) and NB Private Equity Partners (NBPE). All now free from the shackles of burdensome regulation.
Disclaimer: The information contained in this article does not constitute investment advice or a personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial advice as to the suitability of any investment decision. Past performance is not a guide to future performance. The value of investment company shares, and the income from them, can fall as well as rise. You may not get back the full amount invested and, in some cases, nothing at all.
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