Go big or go home

Two of our analysts debate whether trusts consolidating and getting larger is good or bad for investors

The rich get richer has been the market’s watchword over the past few years. The momentum has been behind the largest companies in markets around the world, whether that be AI-related names in the US, large cap luxury brands or healthcare giants in Europe, or the banks in Japan. There are specific drivers in each case, but perhaps there is also a general preference for size, liquidity and momentum, linked to technical factors in how we invest, both in terms of the strategies and the infrastructure we use. In the investment trust space, something analogous has been happening, with boards seeking to get scale quickly. Here two of our analysts debate whether this consolidation is a good thing for the end investor, or if it is to be regretted.

Greed is good – Thomas McMahon

Is there really such a thing as ‘capitalism’? It always struck me as a term that was defined by its enemies. In other words, it was communists who defined capitalism as something they were against, whereas nobody really agitated for ‘capitalism’ as it emerged from the Middle Ages. People fought for economic freedoms: the freedom to choose what work to do, and to spend or invest the money they earned how they wished. I’m not going to go all libertarian here – as far as I am concerned there is a vital role for the state in a good society, not least in providing the laws and regulations that make a free market economy possible and ensuring that might makes right doesn’t make it collapse into its opposite. But I always thought ‘economic freedom’ was much better branding for something that should be celebrated.

Call it what you like, one of the most powerful features of a capitalist society, or an economically free society, is that it directs money, energy and time to what has value to people, and this has a compounding effect in refining, developing and producing more of it. At the risk of losing a lot of readers here, as other people’s holidays currently have an image problem, I would point to the overseas vacation as a classic example. This is now something that is open to the majority of the population, and not just a luxury. According to the Association of British Travel Agents, 52% of people took a foreign holiday in 2023, down slightly on the 64% pre-pandemic peak in 2019. Huge investment by industry across multiple sectors over many decades has given us what we want.

In our sector, the same forces are at work, directing time, energy and resources to the funds that give people what they want. I think this is one of the key driving factors behind the consolidation in the investment trust space. Take JPMorgan Global Growth & Income (JGGI), for example. Over the past two years or so, it has absorbed three trusts with very different approaches to investing globally that had struggled to get to scale. The combination of a quality growth portfolio with an optional income is clearly highly appealing to a broad variety of investors, while the successful execution of the strategy, evident in strong performance numbers, has built confidence in the managers. Or take the absorption of UK Commercial Property’s assets by Tritax Big Box (BBOX). Just as consumers want cheap Amazon deals, investors want to own the logistics network that makes them possible, and the market is giving them what they want.

For this reason, I think the current wave of consolidation is to be celebrated. There have been plenty of trusts on persistent discounts for years that just haven’t been wide enough to prick boards into doing something about it, and the shakeout of the past 18 months or so has forced action. There will be time for a thousand flowers to bloom, but now is the moment to cull the ancien régime.

In this process of creative destruction, there will be good strategies that go to the wall; that is a sad fact. But there are plenty of other benefits to consider. Larger vehicles should be more liquid and reduce trading costs, as well as reducing the cost drag of the average pound invested by the UK investor. As such, this will increase the efficiency and productivity of the capital we invest. And then there is the potential for larger vehicles to spend more on marketing, gathering more assets and creating a virtuous cycle of growth. A potential test case is Henderson European (HET), which has been formed by the combination of Henderson European Focus and Henderson EuroTrust. The new vehicle has total assets of over £700m and has immediately become one of the larger trusts in its sector. I also think the retail shareholder should welcome the presence of larger institutional investors, which is something that is opened up as investment trusts grow. Professional investors are better placed to influence boards and ensure that shareholders’ interests are being represented and protected.

Finally, we should celebrate the exit opportunity that consolidation usually brings. It is good practice for boards to offer shareholders the chance to redeem some or all of their investments as a part of the deal. These sorts of opportunities are essential to ensure that investors don’t fear getting trapped in shares on a discount, even when NAV performance has been good. Capitalist societies don’t trap their members in investments for their own good, but let them free to make their own future.

Be careful what you wish for – Alan Ray

One way to take this side of the argument is to play devil’s advocate, which might be fun as an exercise for the writer, but really, who doesn’t think consolidation is a good thing? Bigger investment trusts benefit from economies of scale, appeal to a wider range of investors and benefit from better liquidity. It’s quite likely that larger investment trusts will get better terms on debt too. And, if the worst happens and the board decides that a new manager is required, the competition to take on a large mandate could be fierce, attracting managers who might not want to run a £100m trust, but who might cut a very attractive deal on fees for a £1bn one. Hard to argue against any of that, right? So instead, let’s ask a different question. What is actually driving consolidation and can we learn anything from that?

The story arc of the last 30 years for conventional investment trusts goes something like this: in the 90s investment trusts saw a wave of selling as their long-standing institutional owners parted ways to manage equities directly in-house. The result? Persistent discounts and a flood of corporate activity and buybacks. Insert your preferred cliché about history rhyming here. Riding to the rescue in the noughties, the burgeoning wealth management industry took up the slack and became the sector’s largest holder. Then as technology and access to information improved in the teens, retail investors followed, and today those two groups are essentially the main holders of conventional investment trusts.

Simultaneously, wealth managers, for commercial but also regulatory reasons, began a long period of consolidation, which continues today, with larger wealth managers responsible for tens of billions of client money. And with that comes the ‘investment trusts need a minimum size’ era. This started out at £100m, soon became £200m and today it’s often held to be £500m. These figures exist in a slightly grey area where there are exceptions and caveats, but they are real and are part of what is driving consolidation. Wealth managers are obliged to deal for all their clients in a consistent and fair manner, and thus it becomes increasingly difficult to deal across many accounts in smaller investment trusts where an order might need to be ‘worked’ by a broker over several days, at different prices and sizes. Another very real challenge is that larger investors are reluctant to own more than a certain percentage of an investment trust, 10% say. This makes total sense, as if one owns a very high percentage of a trust, or any other listed company, one can run into practical challenges in both buying and selling. These aren’t challenges that wealth managers really want to take on, so it’s not hard to see why these minimum size limits have become so important. Much of this paragraph could have been written ten years ago, but alongside some more recent mega-mergers in the industry, higher interest rates have led to bigger discounts and thus the logic for consolidation has become inescapable.

I should say at this point that consolidation in wealth management isn’t a one-way trend, and there are plenty of newer wealth-manager-style organisations that aren’t burdened by the huge weight of capital of the giants in the sector, so the investment trust story arc is already moving to another chapter, and there will be a further shift in the shape of share registers over the next decade. My point is that because consolidation is so often a ‘good thing’ there is a narrative that has developed that it’s good for everyone all the time.

At this point I’d invite readers to browse their website of choice for investment trust and other fund data (information is easily accessible, right?) and have the pages for the UK Smaller Companies sectors open for both investment trusts and for other funds. When a smaller company in the UK wants to raise capital, these two lists form the foundation for the phone calls that will be made to try and raise that capital. It’s not actually that long a list, is it? In fact, the list is quite a bit longer, but in terms of the players who you and I can buy in fund or trust format, this is basically it. Every one of those calls could be the difference between a company raising capital for growth or not. These funds are, if you like, the stock market’s Dragon’s Den. As ever, simplistic bold statements like that come with all kinds of ‘yes, no, maybes’, but hopefully it helps convey the concept.

Keeping our UK Smaller Companies investment trust list open, let’s do some quick calculations to consolidate the sector into a few vehicles that meet that £500m threshold. There are 24 smaller companies trusts, of which only five exceed that threshold, so, with a bit of consolidation, we are down to less than ten in total. That’s not a lot of phone calls is it? A not-very-random sample of how much capital some successful companies have raised on their first IPO gives us Amazon raising $54m, Microsoft $61m, Nvidia $42m and, not to leave the UK out, ARM Holdings, £12.5m. Small amounts of money can, then, be the start of some extraordinary stories and how many of those companies would have raised that money if every investor had a minimum investment size of $50m?

To reiterate, in many cases consolidation is a very good thing, probably the best thing for shareholders. But I think that it’s acting as a little bit of the proverbial canary in the coalmine, in that it hints at a future where capital ends up in fewer hands, making it just that bit harder for the CEO of the small growth company to win the pitch that secures the funding that grows the company that creates the jobs that grow the economy. I don’t imagine this is the first time someone has observed that consolidation among fund or wealth managers will lead to fewer choices and that many of the drivers behind industry consolidation are commercial, and that’s fine by me. But some of the drivers are regulatory, in large part due to well-meaning attempts to shield investors from risk. In my view a successful stock market needs to be a provider of risk capital from diverse sources, and not simply a provider of weight of capital, and that’s something I think the UK needs to think about very carefully.

Disclaimer

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.