This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.
One of the key benefits of investing in an investment trust is the fact it has an independent board. As with any other publicly traded company, the role of an investment trust board is to act as a conduit between investors interests and management.
This may seem like something procedural and not worthy of discussion. But investment trust boards can provide substantial value to investors and have a major role in how an investment trust is run. So even if they aren’t managing its investments, it’s still vital to understand what they do.
A major role investment trust boards play is in negotiating management fees. Clearly investors want these to be as low as possible so they can maximise their return.
At the same time, paying quality managers to run an investment trust and make those important ‘buy’ and ‘sell’ decisions is something investors need to be cognisant of. There’s no point in having a very low fee if you also have very low returns.
An investment trust board helps manage this process by balancing the interests of both parties. Over the last few years, this has resulted in substantial reductions in costs for shareholders. For example, scrapping performance-related fees has been common in recent years.
Investors should not expect the board to be constantly attempting to chip away at fees. As noted, this is a two-way process. But that’s far superior to it being a one-way street in which the shareholders have no say in the fees they pay and no one to support the concerns they might have.
Setting dividend policy
Dividends are usually a key concern for investment trust shareholders. Trusts are also set up in such a way that they must pay out at least 85% of the income they receive if they want the trust’s investments to remain free of capital gains tax within the fund. The remaining 15% can then be put into a reserve and used to pay out dividends in the future.
At the same time, investment trusts can also in some circumstances pay dividends from capital. This means they can pay a dividend to shareholders from cash holdings or share sales, without the need to actually receive dividend payments from their underlying portfolio.
All of this makes dividend policy a major part of many investment trust’s operations. Setting the policy is a key area where the board plays a significant role.
For instance, growth-oriented investment trusts may have a board that decides to pay a dividend from capital. This can appeal to investors that want to invest in growth stocks but don’t want to miss out on dividend payments. Alternatively, a board may ensure a certain level of revenue reserves (previously retained income) to ensure future dividend payments can be made, and ensure a smoothing out of future payouts.
As with fees, the point here is that the board acts as a go-between for shareholders and the trust’s managers. There is no guarantee a board will be pushing for ever higher dividends but investors can have their voices heard and influence how a trust pays out dividends.
Managing discounts and premiums
Arguably the most frustrating part of being an investor in investment trusts is the potential for discounts and premiums.
Discounts, when a trust’s share price is lower than the value of its underlying holdings, can potentially be a good opportunity to buy. But for those wishing to get full value for their investment, it can also be frustrating as a trust’s share price may not reflect its ‘true’ worth for long periods of time and reduce shareholder returns as a result.
It’s a somewhat similar state of affairs with premiums, when a trust’s share price is greater than the value of its underlying holdings. This can put off prospective investors as they don’t necessarily want to pay for shares that cost more than they’re ‘worth’.
An investment trust board can play a key role in diffusing some of these problems by initiating buy-back programmes when shares are at a discount or issuing equity when they’re at a premium. The former theoretically raises the price of shares and the latter should move it back down.
This system is not perfect as share prices fluctuate whenever markets are open. But it does reduce some of the frustration that can come with investing in investment trusts as investors can feel more certain that their shares will trade in line with the value of the trust’s portfolio.
Hiring and firing
Arguably the most important role an investment trust board can play is in determining who should manage the trust’s portfolio.
It is, after all, the trust’s managers that are doing the important work of investing and generating, or not as the case may be, returns for shareholders.
If a trust manager is not performing well then the board can decide to get rid of them and hand the mandate to someone else. This isn’t an idle threat or something they can do in theory either, as boards have done this frequently over the past few years.
Performance is likely to be the main driver of a board’s decision to ditch a fund manager. It can also be due to other factors though, notably a long-standing discount.
Part of the role a trust management team plays is to convince investors to actually buy shares in the trust. This may seem odd as you’d expect performance to speak for itself and investors to buy shares in an investment trust that’s doing well.
That is the case a lot of the time but not all of the time. And if a trust trades at a continual discount to its net asset value then it doesn’t matter how well it’s done as returns for shareholders are going to be less than they potentially could be.
Such a situation could result in an investment trust board deciding to move to a different fund manager, even if the performance of the existing one hadn’t been bad.
The bottom line
This is not an exhaustive list of what investment trust boards do but it highlights the key contributions they can make for shareholders.
The main thing to reiterate is that they act as a guardian of shareholder interests, balancing between what they need with what is feasible for the fund manager.
That means shareholders may not always get what they want but, at a minimum, they can make it clear to the board what they expect from the trust.
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