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Make or break

Rising costs and confusion between the responsibilities of managers and the independent boards of investment companies are some of the potential implications of draft rules issued by the European Commission last week.

The new legislation is targeting non-Ucits funds, particularly private equity and hedge funds, but investment companies are caught in the net and the ramifications could be serious for the industry.

Association of Investment Companies head of public affairs Guy Fairbird says the rules are still in draft form and the AIC will work to steer investment companies out of this net in the coming months.

The rules, as currently drafted, will have an impact on the managers of investment companies running more than euro100m.

That euro100m does not relate to the size of the investment company but instead encompasses all that a manager runs combined as the legislation is aimed at managers directly, not the individual funds.

For example, a fund manager running three investment trusts all £40m in size would fall under this EU directive.

Fairbird says: “The aim is for EU regulators to have greater influence over non-Ucits funds by imposing obligations on these managers. The directive is poten-tially very disruptive as it fails to recognise how invest-ment companies operate.”

Many aspects of the EU directive would cause confusion between the managers and boards, with many responsibilities overlapping as a result.

While the EU directive could pose serious problems for the investment company sector, its managers and boards face a number of other issues in the coming months as they tackle not only a changing regulatory environment but the economic crisis.

For a sector which is looking appealing in light of its structure of independent boards and featuring attractive discount opportunities, the changes could make or break several funds in this space.

Delegates at the recent AIC directors’ conference heard that investment trusts need to consolidate and shareholder engagement needs to improve if companies are to survive the current crisis.

Although the sector’s prospects look strong in a world where corporate governance is valued and the independence of boards controlling these companies is an attractive part of their structure, the industry still faces some needed change.

Cenkos Securities head of investment funds Charlie Ricketts believed the future is strong for investment trusts in the UK retail space, with good, well run companies likely to continue. However, he also saw great need for companies to change the way they operate.

He questioned whether the mandate of some portfolios should change with the times and not continue to operate as they had done for years. For example, he noted that quasi-tracking investment mandates are not needed, especially in light of the lower-cost ETF structures.

Ricketts said: “Consistency is a good thing but so is relevance. Investment trusts need to move with the times and need mandates that are relevant. The role of boards is to lead the relevance debate.”

He claimed that the heart of this sector is in reasonable shape but that more could be done. Critical to the sector is the need for consolidation. “We are often told that £100m is the qualifying threshold for buy lists for trusts,” he said. And yet there remain many small trusts.

Ricketts noted that there are more than 300 investment companies, including more than 80 conventional trusts, with market caps below £50m and about half of the conventional funds have market caps of less than £25m. But those companies with less than £25m in assets have half the liquidity of bigger funds, three times the average costs and twice the discount. He said: “The data points to a clear need for consolidation.”

Ricketts pointed out that in the past decade, half of the 42 trusts in the once popular smaller companies sector have merged, liquidated or wound up. Yet when problems hit hedge funds, they moved far more quickly to resolve the issues, with more action taken in 10 months than in 10 years among investment companies.

He said: “Many of the sub-£50m mainstream funds trading on wide discounts and without genuine prospect of future capital raises should merge or arrange an orderly wind-up.”

Rensburg Sheppards director Andrew Bell said investment companies were favoured by wealth managers but most especially those which operate and perform consistently.

He said: “We are more interested in a fund that does a little bit well for a long period than one which outperforms by some 70 per cent in one year but melts down in the next.”

Bell also agreed with Ricketts that a relevant mandate for a fund is increasingly important.

Investment companies got support from Financial Services Secretary Paul Myners, who also spoke at the AIC’s conference. He pointed out that the governance model is a major advantage to the funds and should be promoted but noted that their sale, due to the lack of commission on offer, has been a headwind. Myners said he believes that the FSA’s retail distribution review should go some way to levelling that playing field.

While praising the structure of investment companies and their independent boards, Myners contends that there is much work that can be done and board directors should be more proactive, particularly in the area of shareholder engagement. There is a need for directors to lead on engagement in the companies in which their funds invest and demand information that is necessary.

He said: “How many boards asked their managers how they have engaged with banks during this crisis? We need more emphasis on engagement to ensure managers are doing this job properly.”

AIC director general Daniel Godfrey encouraged board directors to not only be proactive in terms of engagement but also with regard to policies which could lower discount volatility such as share buybacks.

Although increasingly, wealth managers and investors are finding opportunities in the investment company space, the sector as a whole faces a few challenges in the months ahead, some positive and others posing serious roadblocks.

Which ones survive will depend on not just performance of the fund but on the adaptability and forward-looking attitudes of their boards.


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