When is a cost not a cost?
We know from their track record that investment trusts (also known as investment companies) are a superb investment vehicle for private and institutional investors alike. Yet the sector is uniquely suffering from a regulatory regime which is making for a ‘double-counting’ of their costs, and this in turn is making them appear unduly expensive. Investors are shunning them as a result. This is contributing to discounts having recently been at their widest since 1990, apart from a moment during the financial crash of 2008-09, while elevated discount volatility is resulting in further selling pressure.
As we enter 2024, after some lobbying, the Government is legislating to address the issue in order to provide the necessary ‘cover’ for the Financial Conduct Authority (FCA) to amend its guidance accordingly. Sector stakeholders now have a golden opportunity to solve the problem. Let’s hope they resolve their differences, pull together, and convey a common message for the benefit of the sector and investors alike. Much depends on it.
The problem
The issue has a long and complicated history. Investment trusts were incorrectly embroiled in EU regulation involving mostly MiFID and PRIIPS some 10 years ago, because of which they are having to roll-up their corporate costs (financing, managing the assets, etc.) with their investment managers’ charges when disclosing a cost figure. The sector was never truly understood by those responsible – these companies largely being an alien concept on the continent. Since then, the authorities here have been content maintaining this disclosure regime, and indeed reinforcing it last year since when the issue has escalated.
This double-counting of costs makes investment trusts look unduly expensive. As such, given an incorrect industry emphasis on cost disclosure rather than performance net of fees, these companies in general are being increasingly shunned by institutional investors, IFAs, wealth managers, platforms providers and private investors alike. While other factors contribute, such as higher interest and discount rates, this is a key reason discounts have drifted. To a certain extent, this becomes a self-fulfilling downward loop in that investors are discouraged from buying despite the attractive discounts on offer, and so prices decline further.
Meanwhile, given the industry is struggling to raise monies because of the extent of discounts, private investment in vital sectors such as renewable energy and infrastructure assets has almost dried up entirely. In fact, the situation is worse than it first looks in that the boards and managers of these companies are actively buying their own shares both by way of buybacks and tender offers to help create demand and clear stock overhangs so that discounts may narrow. This is diverting company funds away from their underlying investments and so, in effect, reducing capacity.
The extent of this problem for the country should not be underestimated. Investment companies account for nearly 40% of the constituents of the FTSE 250 index and four are FTSE 100 companies. In the last decade prior to the market effectively closing, they have raised over £60bn for the assets named above and other alternative assets such as technology start-ups, student accommodation, social welfare investment, etc. These companies have been one of the world’s great successes in attracting private investment into these worthwhile causes.
This cost-disclosure regime does not exist in other countries. The UK is the only market in the world where public companies (including investment trusts) are subject to any form of MiFID and PRIIPS regulations and therefore report costs and charges. And they affect c.90% of the UK sector’s companies. The irony is that not even the EU now adheres to these regulations – not a single company listed on any EU exchange is now subject to these MiFID and PRIIPS regulations. Only in this country are we still adhering to, if not gold-plating, such regulations.
I would go further and question whether investment trusts should have to declare any costs at all from a regulatory point of view given their share prices already capture such information. Prices reflect investors’ assessment of such costs. These costs have already been absorbed within the declared net asset values (NAVs) of the companies in question. The market has spoken. Transparency of investment and other charges can be achieved by these costs being listed in company factsheets, Report & Accounts, web pages, in the footer of press releases etc.
No other public company has to abide by the same level of misleading cost disclosure. M&S and BP do not have to report their costs, despite the extent of these costs in managing a wide range of (sometimes expensive) assets. These costs are reflected in share prices – the market has taken them on board. The same should be true of investment trusts given they too are public companies managing a range of assets. A change of mindset is required. The answer to the headline question is when the share price has already been adjusted for the cost.
The remedy
A few of us in Parliament have lobbied the Government – with the help of the Treasury Select Committee, the Chancellor has listened. I have focused on the cost-disclosure issue and the need to provide the required legislative cover regarding MiFID/PRIIPS to allow the FCA to issue the necessary change in guidance. Meanwhile, Ros Altmann and Sharon Bowles are introducing a Private Members’ Bill in the House of Lords which focuses on the AIFMD regulations and a wider range of issues important to investment trusts, including capital requirements.
The Government has accepted the urgency of the situation. A meeting with the Economic Secretary, the able Bim Afolami, confirmed they get it. Two Statutory Instruments (SI) are being introduced to the House of Commons. SIs secure modest changes to legislation quickly, without having to pass another Act – they are secondary legislation amending primary. These will, in effect, place the MiFID and PRIIPS regulations onto the FCA rulebook – thereby providing the legislative cover for it to introduce the required guidance change. The technical consultation for the first finishes on 10 January. The second is forthcoming.
The FCA will then consult the sector as to the remedy. I have asked the FCA to start its consultation now, given the urgency and legislative cover is forthcoming. The Government has also asked the FCA to introduce interim measures. I have further asked the FCA to confirm these will provide short-term relief. Again, it has promised to get back to me. The good news is that the FCA, Government and we three Parliamentarians all agree the MiFID/PRIIPS regulations are the primary problem regarding costs. Ministers have also confirmed they are prepared to go further if required. We at least are on the same page.
One of the key litmus tests as to whether the FCA’s interim measures and revised guidance are successful is whether the cost figure companies disclose (in abiding by the guidance) on the European MiFID Template or ‘EMT’ feeds used by sector participants are adjusted accordingly. It has been because of these elevated costs that platform providers have been withdrawing companies, thus denying private investors choice, and investors have shunned companies. The cost of Aberdeen Private Equity Opportunities (APEO) has been cited at c.6%, whereas the investment managers’ charges are nearer to just 1%.
Like many of its peers, APEO has a very good track record of asset performance which surpasses many ‘cheaper’ trusts managing less costly assets. Yet private equity discounts of around 30%-40%, wider than the sector’s average, at least in part reflect a regulatory obsession with cost at the expense of value. Regulation must not result in the stability of the graveyard.
Examples of other companies where sentiment is poor at least in part because of this cost disclosure issue include those highlighted in my last column (‘Renewable energy opportunities’, 17 November 2023), HICL Infrastructure Company (HICL) and International Public Partnerships (INPP) within the infrastructure space, and Abrdn Property Income (API) within commercial property. All stand on substantial discounts and offer attractive yields. Robust revenues and cashflows, the advent of interest and discount rates falling, and more realistic cost guidance, could make for a powerful combination.
Golden opportunity
When it comes to the FCA consulting the sector, the chances of success increase substantially if all stakeholders are singing from the same hymn sheet – a point the Economic Secretary rightly made during our meeting. My worry is that we are not there yet, and time may be short. This is a golden opportunity to put right that which is damaging the sector, its investors, and investment in the country. It is essential the sector seizes the moment, takes advantage of the legislative cover provided by the Government, and sheds this misleading guidance.
It is especially important that the Association of Investment Companies (AIC), the sectors’ trade body, and the wider sector and members it represents, are in lockstep. We are not there yet. We should all start from the premise that investment companies are listed equities – like M&S and BP. As such, comparisons with open-ended funds like unit trusts are hardly valid, given their share price is directly connected to their NAV – unlike other public companies, including investment trusts. A key focus should be the all-important EMT data issue, while ensuring all investment trusts abide by the same guidance.
Alan Brierley, the respected Investec analyst, has confirmed this is the most challenging environment that he has experienced in his nearly 30 years covering the industry, and that the cost disclosure debacle has been a key driver of this. Moreover, he believes the industry’s slow reaction to the imposition of this ill-fitting regulatory framework, and its underestimation of its impact has been underwhelming. Brierley said: “the AIC’s proposals appear to have been formulated on the basis of the current regulatory and legislative environment, and do not reflect the legislative cover that is now being provided.”
A recent meeting in Parliament (involving industry and company representatives, managers, the AIC, the Investment Association, and Parliamentarians) saw attempts to resolve differences. Some progress was made. Further meetings are due. The opportunity is there to take.
Disclaimer: The information contained in this article does not constitute investment advice or personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial and, if appropriate, legal 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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