Boards faced with underperforming managers have a tricky balancing act to perform. Investors may have bought the trust because they like the manager and the investment style that comes with them. They might be prepared to look past short-term performance problems and might not take kindly to their favoured manager getting fired. Or a board might fire an underperforming manager and employ one that has done better recently only to see a reversal in fortune.
Poor performance is often accompanied by a widening discount, which makes the situation worse.
Boards have various levers to pull before finally pulling the plug on a manager. This week, we got to see some of these in action with two different trusts.
Witan Pacific, which has an Asia including Japan strategy and operates with four portfolios managed by different managers, has been struggling for many years. In fact, over the almost 15 years since its investment strategy was adopted, it has underperformed its benchmark by 6.8%, which will make investors question why they are paying up for an actively managed strategy. Unsurprisingly, the board and shareholders are losing patience.
The plan that the board came up with, well over a year ago, is to offer investors the chance to cash in their investment at a price close to NAV if the trust fails to beat its benchmark over the two years ended 31 January 2021. Witan Pacific has just reported results for the first half of that period and the picture isn’t good. Three of the four managers failed to beat the benchmark and, at this halfway mark, the trust was lagging 3.5% behind its goal.
The threat of losing most if not all of the fund ought to be fairly motivational, but it is also a fairly drastic solution. Trusts are expensive to launch and normally hard to grow. We hope that, if it comes to it, the board considers offering shareholders a rollover into another trust as well as a cash exit.
Aberdeen New Thai’s board has instituted something similar. Here the measurement period runs over the three years ended 28 February 2023 but the promise is that, if the trust fails to perform, there will be a review of the investment management arrangements which may include offering a cash exit.
However, this comes on top of a continuation vote triggered if the average discount exceeds 15% over the 12 weeks running up to the company’s financial year end, and a switch to basing fees on market cap (which is another way of incentivising the manager to get the discount down – although perhaps taking an average over the entire financial year provides far better alignment). We also note that the manager has beefed up the team managing the trust, which suggests it still sees merit in the strategy and is keen to keep the mandate.
We will see how both of these play out in the coming weeks, but it’s not always plain sailing, even once a decision has been made to oust a manager. Perpetual Income & Growth, which we wrote about a few weeks ago, is yet to announce who will succeed Mark Barnett as manager. Shareholders in Edinburgh Investment Trust, whose board jumped first and ended up appointing Majedie Asset Management, were not given the option of a cash exit. That trust is still trading on one of the widest discounts in its sector and has not covered itself in glory since Barnett’s departure (ranking towards the bottom end of the performance league table in 2020). Once a new manager has been appointed, there will inevitably be a period of adjustment while the new manager realigns the portfolio and it will then take time for a hopefully improved performance to show through.
At present, those shareholders that stuck with Edinburgh will be just as frustrated as they were before. In these circumstances, we think it is important to have a chance of an exit close to asset value. However, it should not be the only option. Some investors, who have held a trust for an extended period, may run the risk of crystallising capital gains that can be avoided with a good rollover option.
We think that, where possible a rollover should include the choice of a closed end vehicle with the benefits this structure affords so that, in the event of a manager is not performing, shareholders have a board on their side who can take action on their behalf. It may not be easy but, at least with a closed end fund, boards have levers they can pull to address poor performance. With an open-ended vehicle, the only real recourse for unhappy investors is to vote with their feet and sell out of the fund. Open ended funds will never truly be investor friendly until this issue is addressed.
Well said