2023/2024

Welcome to the 2023/24 Backwards and Forwards Zone

Are you finding yourself thinking about 2023 and 2024 in equal measure? If you are, fear not you are not alone. For chances are you’ve entered the BFZ – the Backwards and Forwards Zone. Confused? Have a read of the latest Doceo Insights and all will become clear…

ByFrank Buhagiar•28 Dec, 2023

It’s that time of the year again. No, not Christmas – although it is the festive season of course, it’s just not the topic for this piece. No, it’s also that time of the year when the baton is passed from the old year to the new. A time when commentators can find themselves afflicted by a temporary but nonetheless chronic condition – one that seemingly makes the victim look in diametrically opposed directions simultaneously, specifically back at the year drawing to an end/just gone and forwards to the one fast-approaching/just arrived. In short, they have entered the Backwards and Forwards Zone. London’s investment trust world is no exception. Neither is this commentator…

The Backwards bit

This year’s entry into the zone prompted, like last year, by the Association of Investment Companies (AIC) Investment company 2023 review, which was published with a couple of weeks to spare on 13 December 2023. The AIC’s roundup kicks off with the following:

“2023 has seen four mergers between investment companies, eight liquidations and eight investment companies change managers as boards responded to difficult market conditions and deep discounts, according to data from the Association of Investment Companies (AIC).”

“…difficult market conditions and deep discounts…” – 2023’s been a tough one for London’s investment company space.

The review continues: “There will be nine manager changes in total following the appointment of Asset Value Investors to manage MIGO Opportunities on 15 December – the largest number of manager changes in a year since 2009.”

Manager changes – a sign of challenging times? 2009 certainly was, courtesy of the Global Financial Crisis (GFC).

Back to the opening section of the AIC review: “The discount of the average investment company has remained in double figures through the whole of 2023, the only year this has happened since the financial crisis. The average investment company discount started the year at 11.7% and hit a post-2008 trough of 16.9% at the end of October before recovering to 11.1%…”

Another reference to the GFC – it was that tough.

One way to try to narrow steep discounts? Deploy buybacks. No surprise then that, according to the AIC, “It has been a record year for share buybacks, with £3.57bn of shares repurchased in the year to date, compared to £2.70bn during the whole of 2022, a 32% increase, according to statistics from Winterflood and Morningstar…”

Big jump in buybacks – a symptom then of a difficult year.

Other headline grabbers from the AIC review tell a similar story:

• Only two initial public offerings (IPOs) year to date…safe to say that tally won’t be added to between now and the end of the year – Ashoka WhiteOak Emerging Markets listed on the London Stock Exchange after raising £30.5 million; and Onward Opportunities listed on AIM in March, raising £12.8 million

• £1.1bn in secondary fundraisings (funds raised by existing investment companies) year to date, sharply lower than last year’s £5.2 billion

• £6.32bn dividends paid out by investment companies during the first 11 months of the year, a 14% increase on the previous year’s £5.55bn

• Total industry assets of £260 billion as at end of November, £5bn off the £265bn at the start of the year

• 26 investment companies altered their fee structures. According to the AIC: “The most common type of fee change was a reduction in a company’s base fee (11 companies) and the second most common was a reduction in a tiered fee (10 companies). In addition, 7 companies introduced tiered fees for the first time and two companies removed their performance fees…”

All in all, the passing of 2023 unlikely to be mourned by London’s investment companies.

The Inbetween bit

Several interesting threads among the various stats in the AIC Review to pick up on: how the steep discounts peaked in October and then narrowed; the high level of mergers and liquidations; 26 companies lowering their fees. Each worthy of a closer look:

Post-October narrowing of discount rates – as previously reported in Doceo Insights Was it all down to the commentator’s curse?, the post-October narrowing in discounts coincided with a drop in bond yields. Hardly a surprise. In the above Doceo Insights, the finger of blame for those wide discounts in the first place was largely pointed at…higher bond yields: ‘Winterflood’s Emma Bird, as quoted by interactive investor back in September 2023, singles out higher bond yields: “Government bonds now offer a meaningful yield for the first time in many years, which has led to significant equity outflows in order to support growing fixed-income asset allocations. Furthermore, asset classes such as infrastructure and property have been hit particularly hard, as investors anticipated a fall in net asset values due to the impact of rising discount rates and an increased cost of debt, while share prices also fell as the yield pick-up versus UK gilts narrowed, making the trusts look relatively less attractive.”’

It follows then that were those bond yields to fall, then those wide discounts would likely shrink too. As the same Doceo Insights article noted: ‘…the week ended Friday 3 November 2023 saw a significant downwards move in bond yields…10-year US Treasuries ended the week around the 4.5-4.6% level. Significant daylight then between those levels and the 5% mark that had been prevalent for much of October, a month that saw more and more investment companies caught up in the discount doldrums.’ Cue a reduction in the number of investment companies trading at 52-week high discounts: ‘…41 trusts trading at 52-week high discounts over the course of the week ended 3 November 2023, is already 15 fewer than the previous week’s 56.’

Not all down to bond yields though. Other dynamics were highlighted by Winterflood’s Ms Bird too. Back to the above Doceo Insights: ‘According to Ms Bird, the discount widening seen “…is likely caused by a number of factors, including: some investors favouring fixed income over equities, institutional investors experiencing outflows from their own funds, retail and institutional investors awaiting more macroeconomic certainty before (re-)entering the market, and concerns over the perceived costs of investment trusts in light of cost disclosure rules, particularly following the publication of Investment Association guidance last year.’

The high level of mergers and liquidations – brings to mind another Doceo Insights piece Two mergers, one wind down and a sprinkling of gold dust which was centred around broker Winterflood’s list of Potentially Sub-scale Funds, a list that, at the time of writing, had successfully predicted “Two mergers, one wind down, one potential wind up – four (potential) servings of corporate activity across the combined 13-strong watch list. Quite some return. And that’s just after a little over six months. Winterflood’s Sub-scale Watch List – one to watch…”.

Now, when putting together the list, ‘The broker looked for common themes from the various deals that had been announced in the run up to May 2023, particularly those involving funds deemed to be sub-scale. As Winterflood writes: “…three key themes emerge. Each can be used as a lens for assessing which trusts in the universe may currently fit the definition of sub-scale, and hence may be susceptible to upcoming corporate action.’ With nine more names on the list, who’s to say Winterflood won’t add to its score?

The high level of mergers and liquidations, yet another sign of a challenging 2023, but also evidence that the investment company space is putting its house in order – smallish funds are looking to merge to achieve scale and become more attractive to investors; and trusts are electing to wind themselves up and return capital to shareholders, capital which could be reinvested elsewhere in the sector.

26 companies have lowered their fees – what about Ms Bird’s ‘concerns over the perceived costs of investment trusts in light of cost disclosure rules…’? Over to broker Numis for a quick recap: “The cost disclosure issue centres around the fact that there is a single cost number in the KID document which is used by investors, such as private wealth managers and multi-asset/manager funds, and aggregated into their own cost disclosures to their underlying clients. As a result, Investment Companies look expensive in a portfolio versus direct equities…” In short, not a level playing field for investment companies which are made to look more expensive than other vehicles.

Here, there have been definite signs of movement – cost disclosure rules were recently debated in Parliament and are seemingly on the government/regulator to-do-list. A start at least. If the result is a more level playing field in terms of cost disclosure, then according to Numis this “would give much greater scope for a range of investors to increase exposure to the Investment Companies sector or return after exiting their positions.” One to keep an eye on then, but with 26 fee rates effectively lowered during the year, investment companies are already helping themselves on the cost front.

Tailwinds provided by lower bond yields; investment companies taking action to make themselves more appealing to investors either by increasing their scale or lowering their fees; funds winding down and returning capital to investors – all brings us on to…

The Forwards bit

For it’s just possible that these positive developments/trends will persist and, in the process, help lay the foundations for a much better year for London’s investment companies. Cue forwards-looking commentary from investment company investor MIGO Opportunities (MIGO) extracted from the fund’s recently published Half-year Report. As investment manager Nick Greenwood writes in his Review:

“We have heard the death knell sounded for investment trusts many times before. The sector has always evolved and progressed.” The fund manager goes on to explain that: “There are self-help measures which can be adopted. Oversupply can be dealt with via buy backs. The law of natural selection is alive and well in the world of closed end funds and we expect to see the recent trend of mergers and wind downs to continue. There are new audiences to focus on, such as self-directed investors and newer wealth management businesses often staffed by individuals who have departed the vast chains. Despite experimental capital structures being mooted, the closed-end fund is the best structure for accessing illiquid asset classes. The travails of open-ended property funds sum up the challenges and explain why investment trusts will continue to exist.”

The fund manager continues: “In recent weeks the outlook has brightened as expectations of further interest rate rises have petered out. Investors will now anticipate their eventual decline. Many investment trust share prices are languishing at levels which generate attractive yields for investors buying today. Should interest rates actually fall, this attraction will grow further. In the medium term such wide discounts are unsustainable as, if the market fails to properly value closed ended funds for structural reasons, then the real world will claim the underlying assets on the cheap albeit at higher levels than today. Furthermore, should there prove to be a sensible reform of the cost disclosure regime, we should expect trust share prices to rally sharply as investors who have been forced onto the sidelines are allowed to return to the market.”

Before concluding with: “Generally speaking, when discounts have become very wide trust investors have then benefitted from the powerful combination of rising net asset values and narrowing discounts. Given the widespread opportunities to exploit mis pricings, our cash position steadily declined during the period under review and has continued to decline since.” MIGO putting its money where its mouth is.

“The thing is potentially the tailwinds behind the investment trust sector are quite substantial…markets seem more confident, the (FED) pivot is certainly happening in America (and) may happen in the UK as well…So you’ve got potentially declining interest rates (and) cash becoming less exciting.” The same goes for bonds. As David points out: “There’s lots of people who are saying that although fixed income is more interesting, most of the gains have already been made…because you’ve already seen the yields drop down.” And then there are specific features of investment trusts to consider too: “You might see leverage coming in to play i.e. gearing…and that active overlay which should be providing above benchmark returns. That could all be a very strong tailwind behind the investment trust sector…You could move from quite substantial discounts…to quite positive numbers…and that geared return of discounts tightening and the underlying markets doing quite well could be a really powerful tailwind.”

Reaching for the stars

At least two commentators then thinking that with lashings of fair winds and following seas, the stars could well be aligning for a much better year for London’s investment company space (all written with fingers well and truly crossed). But ho ho ho! Enough of looking backwards and forwards (for now at least). Time to focus on the here and now. That means there can be only one more thing left to say:

HERE’S TO A HAPPY AND PROSPEROUS NEW YEAR FOR ALL FROM THE TEAM AT DOCEO.