A champion for shareholders: Keystone Investment Trust
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A quick look at the steps which the Board of Keystone Investment Trust plc (Keystone) has taken to make things better for shareholders…
The role of an investment trust’s board of directors can sometimes seem mysterious, but the board should be – and in this case is – a champion of shareholder’s interests; closely monitoring the performance of the fund manager and working to improve efficiency and optimise the mechanics of the investment company itself wherever the opportunity to do so arises.
The board of Keystone has delivered a number of key improvements for shareholders in the last eighteen months, refinancing the company’s debt and reducing the associated costs, moving to make the company’s shares more attractive to retail investors, and adjusting the boundaries within which Invesco fund manager James Goldstone is able to operate, giving him the freedom to deliver better returns whilst adjusting his risk parameters.
Shifting up a gear
Investment trusts can borrow money which they can then invest on behalf of shareholders – in the same way that they would using money invested directly by shareholders themselves.
This has an accelerant effect on returns because – once the cost of the debt in terms of interest has been accounted for – any excess returns generated by ‘debt-funded’ assets can be distributed evenly among shareholders.
This accelerant effect, which it is important to remember can also magnify downward movement, is behind the term used for this type of borrowing – gearing.
A crucial consideration when it comes to gearing is the cost of maintaining it – the clearest indicator of which is the interest rate attached to the debt – and, just as any homeowner should regularly review their options when it comes to a mortgage, it makes sense for investment trusts wherever possible to replace more expensive debt with cheaper debt should it become available.
The board of Keystone has done just that, announcing in March this year that it had paid off all of the company’s outstanding debts using a new, cheaper, bank facility – the equivalent of an overdraft – with significant interest savings at a negligible cost to the trust’s net asset value.
Saving money on unnecessary interest payments is a good idea at any time, but the timing on this move is particularly welcome given the dividend cuts which are likely to occur in the underlying portfolio as the impact of the pandemic is felt.
At the same time, the board has also altered the ‘throttle’ to provide more flexibility for the Manager in what are very volatile markets. Going forward, the Manager will be unable to make net purchases at times when the net gearing level is greater than 15% of net assets.
If movements in the NAV cause this ratio to exceed 20%, the Manager will now be obliged to reduce the gearing ratio; previously, sales had to be made if the gearing ratio exceeded 15% of net assets.
This move is good news for shareholders; without this flexibility, the current extraordinary market conditions could compel the Manager to liquidate positions at a disadvantageous time and to the ultimate detriment of shareholders.
Optimising the trust’s appeal to investors
A key element of success for any investment trust is an active market for its shares, and so maximising the appeal of a trust’s shares to the broadest possible range of investors is part of the board’s core role.
It took action to improve the return characteristics of its shares in May 2019 when it announced the decision to begin paying dividends quarterly; giving the trust more appeal for investors seeking a regular income at a time when traditional sources – the interest rate on savings accounts being virtually zero – have effectively dried up.
Income seekers are no better off (far from it), and that quarterly dividend should help to put positive pressure under the share price as dividends recover, but the board has gone further, announcing in late December 2019 that it would instigate a share split and a buyback programme.
The five for one share split was made with the objective to make it easier for existing shareholders, particularly retail investors, to buy and sell shares.
The board also announced in December that it would buy back up to six million of the trust’s shares. Substantial buybacks totalling c.5.3% of the issued share capital subsequently took place over December, January and February, with the board buying back shares worth a total of c.£12.25m at an average weighted discount of c.11.9%.
After a period of hiatus, renewed buy-back activity is being utilised – enhancing the trust’s NAV and providing liquidity for the benefit of existing shareholders – if the discount remains significantly wider than that of the wider peer group.
The board recently undertook a five-for-one subdivision of the shares, with the intention of improving liquidity and broadening the trust’s appeal to retail investors.
This became effective on 13 February 2020, and as such it is too soon to make any assessment of its success. However, should both goals prove successful it is reasonable to hope that Keystone could see its discount narrow towards the peer group-average level.
Managing the Manager
The role of the board is to set a framework within which the Manager should operate, and to appoint, benchmark and monitor a Manager who – in the board’s view – is able to deliver the best results within that framework, taking action where required to help the Manager meet performance targets.
It is important, however, that the board provides enough room for the Manager to do their job properly, so a reasonably ‘hands off’ approach makes sense.
The actions taken by the board reflect this. They are supportive of James Goldstone’s investment thesis, and the increased flexibility around the way he can use gearing provides useful resilience at a time when volatility is very high.
At the same time they have given him more freedom to invest overseas – having listened to his view that gold miners in particular, many of which are based in North America, are in a strong position to perform.
The board recently decided to increase the limit on the portfolio’s exposure to overseas securities from 15% to 20%, allowing James to express that conviction by buying more shares in this type of company.
By regularly engaging with the Manager, the board has taken time to understand the challenges facing James in what has been a very difficult period for investors, particularly in the UK where sentiment even before COVID had already been affected by the prolonged horse-trading around Brexit.
Taking what they have learned from that engagement, they have worked hard to provide the flexibility he needs to deliver results, and to create a discount management programme which provides liquidity and enhances the NAV for Keystone’s shareholders.
As the world returns to a more settled footing in the wake of the Coronavirus crisis, with the prospect of some bumps along the way not unlikely, these improvements leave the trust better equipped to serve its shareholders, and the manager in a better position to focus on generating returns in a volatile environment.
The value of investments and any income will fluctuate (this may partly be as a result of exchange rate fluctuations) and investors may not get back the full amount invested.
When making an investment in an investment trust you are buying shares in a company that is listed on a stock exchange. The price of the shares will be determined by supply and demand. Consequently, the share price of an investment trust may be higher or lower than the underlying net asset value of the investments in its portfolio and there can be no certainty that there will be liquidity in the shares.
The product uses derivatives for efficient portfolio management which may result in increased volatility in the NAV.
The product invests in smaller companies which may result in a higher level of risk than a product that invests in larger companies.
Securities of smaller companies may be subject to abrupt price movements and may be less liquid, which may mean they are not easy to buy or sell.
The use of borrowings may increase the volatility of the NAV and may reduce returns when asset values fall.
As a result of COVID-19, markets have seen a noticeable increase in volatility as well as, in some cases, lower liquidity levels; this may continue and may increase these risks in the future. In addition, some companies are suspending, lowering or postponing their dividend payments, which may affect the income received by the product during this period and in the future.
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