Opportunities in regulatory reform
Changes in rules governing the disclosure of charges could drive a rally in investment trusts
The investment-trust sector has been buffeted by strong headwinds in recent years. These stem from significant changes in the regulatory environment and the assetmanagement industry. These challenges can be traced back to the current European regulations on investment products for retail investors, the so-called PRIIPs Regulation. It has had unintended consequences for investment trusts. As trusts are virtually unique to the UK and comprise only a small percentage of the global fund-management industry, the rules were developed with little thought given to these vehicles.
PRIIPs force managers to disclose annual management fees and transaction costs for funds. This makes sense with open-ended funds, as the charges and costs are taken out of returns. But with investment trusts, this level of disclosure around costs is misleading because the costs are already incorporated in the company’s valuation and share price. As a result, charges are effectively being double counted. As asset managers are becoming increasingly aggressive when it comes to excluding high-cost investments from portfolios, that’s a problem. Partially thanks to new consumerduty rules formulated by the Financial Conduct Authority, the city regulator, and partly because they’d rather get better returns for their investors than pay extra fees, asset managers have been avoiding trusts with high fees. Some investment platforms have also been banning trusts, which are perceived to have high fees, from their platforms.
To add insult to injury, as the investment-management industry has grown, both organically and through acquisitions, smaller investment trusts have been excluded from portfolios. Asset managers tend to segregate clients into “risk buckets” (another side effect of regulation) and use a single portfolio template for each risk bucket. That means they will shy away from assets where they can’t be sure they’ll be able to buy enough stock to meet clients’ requirements. Both of these technical factors have acted to drive a wave of trust selling, leading to wider discounts and poor returns.
The good news is that in December, the Treasury said it was working “at pace” to reform cost-disclosure rules. Then, after a disappointing Budget, more than 110 experts backed a letter sent by three members of the House of Lords and an MP calling for changes in investment-trust cost disclosure rules. The most concrete sign of progress came last week when Bim Afolami, the economic secretary to the Treasury, said at the Association of Investment Companies’ (AIC) conference that the government hopes to set out new proposed rules for the sector on costs “very soon”.
What to keep an eye on
This doesn’t mean the disclosure rules will change anytime soon, but it’s positive and worth keeping an eye on. If there are changes in the pipeline, it could be time for investors to consider larger trusts with higher disclosed fees trading at discounts. If the rules around fee-disclosures change, there could be an influx of cash from asset managers and a narrowing of trusts’ discounts to net asset value (NAV). The private-equity and infrastructure sectors are the most appealing for investors thinking along these lines. The HarbourVest Global Private Equity trust (LSE: HVPE) and Pantheon International (LSE: PIN) are two trusts focused on the private-equity sector. According to the AIC, both are trading at discounts to net asset value (NAV) of around 40% and have fees of between 1.1% and 1.25%.
In the infrastructure sector,
3i Infrastructure (LSE: 3IN), HICL Infrastructure (LSE: HICL), and International Public Partnerships (LSE: INPP) have market values of between £2.4bn and £3bn, are trading at discounts ranging from 20% to 8%, and have reported charges of 1.1% to 1.6%.