Head of Baillie Gifford’s Global Marketing, James Budden, argues that the investment trust sector is alive and well, especially for those who capitalise on discounts and their structural advantages.
As with any investment, capital is at risk.
Mark Twain famously said that reports of his death were an exaggeration. This line could have been applied to the investment trust sector many times since 1868.
However, the sector is very much alive and serving savers in the same way as intended by those who brought F&C Investment Trust into this world 157 years ago.
James Budden, Head of Baillie Gifford’s Global Marketing, says investment trusts can thrive
The most recent attempt on its life took place in the first quarter of this year, perpetrated by the New York hedge fund Saba, which over the last two years had built significant stakes in seven trusts which, with a touch of humour, it named the Miserable Seven.
Three of these trusts, Keystone Positive Change, Baillie Gifford US Growth and Edinburgh Worldwide, were managed by Baillie Gifford.
In each case, Saba and its principal Boaz Weinstein asked shareholders to replace existing directors with their nominees and move the investment mandate of each trust to a new asset manager – Saba.
Saba was rebuffed in each case, as shareholders large and small came out in force to vote down Weinstein’s proposals.
It was uplifting to see such a turnout in defence of the industry, something many insiders did not believe was possible. But it was expensive for the trusts and their shareholders and arguably something everyone would like to avoid doing again in a hurry as the whole exercise served no real purpose in the end.
Boaz relied on shareholders’ indifference rather than the credibility of his proposition and was heavily defeated. Most media and commentators saw through his attempt at acquisition, but he did score points with some.
In part, he succeeded in reviving a stereotype labelling the sector as old-fashioned and complacent, with its boards and managers asleep at the wheel. There might have been some truth to this a generation ago. But not anymore, for reasons we will explore.
Understanding discounts
The Saba attack was widely covered in the media. Most journalists and commentators were engaged and generally supportive of the sector.
However, The Economist summed up the issue as follows, ‘It is a damming verdict of the trusts’ managers that their portfolios would be worth more if they were carved up and sold for parts.’
Although technically correct, this statement is a touch ignorant. Yet it highlights the eternal question of the discount, which is a natural by-product of the investment trust structure and a response to an imbalance in supply and demand for trust shares.
Share prices and therefore discounts reflect the underlying liquidity of the portfolio and the likely hit to net asset value were a portfolio to be liquidated in a hurry. Discounts also reflect an estimation of the costs that would be incurred in such a situation.
Share prices also reflect investors’ perception of the managers’ ability to add or subtract value through their decisions. There is a close correlation between wide discounts and trusts that have experienced a period of disappointing performance.
Discounts are not intrinsically bad (more than 90 per cent of trusts currently trade at a discount), but volatile discounts introduce a risk that purchases and sales could be mistimed.
They also invite attention from activists such as Saba and other parties looking to extract value through trading and realising assets.
In recent times, the average level of discount for the sector has been historically wide.
Passive investing has proved popular, powered by the Magnificent Seven, but sentiment is shifting on just backing US giants
Fundamentally, this is because we have been through a tough period for active management.
Passive investing has proved popular, powered by the Magnificent Seven – Apple, Microsoft, Amazon, Alphabet, Meta, NVIDIA and Tesla – while heightened interest rates have made money market and fixed interest funds attractive short-term options.
So, demand has fallen for active investment, but this is not particular to closed-ended vehicles, as open-ended funds have been in outflow for many months. It is just that the discounts highlight the issue.
Should active management return to beating the index, and there are signs that it is, we can reasonably expect sentiment to improve, demand to grow and discounts to tighten.
As shareholders of Baillie Gifford-managed trusts will be acutely aware, our style of long-term growth investing has also been out of fashion.
This may be changing at last. Since 2022, we have seen core buyers of our trusts – intermediaries and individuals – selling rather than purchasing trust shares. The largest buyers have been activists and the trusts themselves through buybacks.
Survival of the fittest
This brings us to Darwinism – evolution through natural selection. Only 1 in 10,000 companies survive for 100 years.
There are more than a few investment trusts that have achieved that milestone and are still going strong. But plenty have fallen by the wayside.
The sector currently has around 300 members, while the number of open-ended funds runs into thousands.
The reason for this disparity is the existence of independent trust boards charged with safeguarding shareholder interests. Open-ended funds are the creatures of their managers, who can have a range of motivations for favouring their continued existence.
Boards must act on behalf of their shareholders, and these days, they are very conscious of their responsibilities, giving the lie to the theory that they sleep at the wheel.
Ultimately, they might decide that a trust is best wound up and returning cash to shareholders. This suggests that only the strong survive, to paraphrase Mr Darwin.
Indeed, boards have never been so busy promoting shareholder interests. The sector is seeing a record number of manager changes, mergers, rollovers and wind-ups.
Partial returns of capital through buybacks and tenders have become commonplace. In many cases, managers have agreed to continuation votes, putting to the test their ability to add value ahead of the index over an appropriate period.
Mr Weinstein has not walked away. He is now taking a more plausible route. He is asking why anyone would accept a discount when they can have a fund offering the same proposition and trading at par. Some shareholders may be compelled to join him on this journey towards unitisation.
Baillie Gifford’s investment trusts invest in private companies too, including SpaceX
It pays to be different
This is why investment trusts must strive to be different from their open-ended counterparts.
They must use their structure to enhance shareholder returns, such as investing in illiquid assets, gearing portfolios, maintaining dividend flows and returning capital through buybacks and tenders when appropriate. Those that simply mirror an OEIC are vulnerable to attack.
At Baillie Gifford, we are focused on being different not just in our growth approach but in how it is captured within the investment trust structure.
Increasingly, our trusts invest in private companies alongside publicly-quoted businesses, accessing such household names as SpaceX. They maintain geared portfolio, facilitate buybacks and work with boards to offer innovative corporate actions designed to benefit shareholders in the long term.
These are all levers that should be pulled, but ultimately outperformance is the key to long-term success and the standard by which managers must be judged.
Encouragingly, there are signs that active investment is becoming more popular as the most herdlike trade – investing in the Magnificent Seven – unwinds. In addition, sentiment may be improving towards growth companies as their operational progress is recognised in share price terms.
A last word on discounts. The attraction is in the word itself. If you can buy on a wide discount, you may have a bargain, and if it stays the same, there is no harm done.
Important Information
Unlisted investments such as private companies can increase risk. These assets may be more difficult to sell, so changes in their prices may be greater.
Investment trusts can borrow money to make further investments (sometimes known as ‘gearing’ or ‘leverage’). The risk is that when this money is repaid by the trust, the value of the investments may not be enough to cover the borrowing and interest costs, and the trust will make a loss. If the trusts’ investments fall in value, any invested borrowings will increase the amount of this loss
The views expressed in this article should not be considered as advice or a recommendation to buy, sell or hold a particular investment. The article contains information and opinion on investments that does not constitute independent investment research, and is therefore not subject to the protections afforded to independent research.
Some of the views expressed are not necessarily those of Baillie Gifford. Investment markets and conditions can change rapidly, therefore the views expressed should not be taken as statements of fact nor should reliance be placed on them when making investment decisions.
Baillie Gifford & Co Limited is wholly owned by Baillie Gifford & Co. Both companies are authorised and regulated by the Financial Conduct Authority and are based at: Calton Square, 1 Greenside Row, Edinburgh EH1 3AN.
The investment trusts managed by Baillie Gifford & Co Limited are listed on the London Stock Exchange and are not authorised or regulated by the Financial Conduct Authority.
A Key Information Document is available by visiting bailliegifford.com