We would hesitate to call it a wave of consolidation – maybe a ripple would be more appropriate – but this year has seen a number of mergers among investment trusts.

There is a long tail of sub-scale funds and trusts in the UK all desperate to attract more investors, but with the average discount to net asset value hitting 18% at the end of October, according to research from Winterflood Securities, there is little hope of them raising funds or increasing their daily liquidity.

One solution could be to merge with a rival, but does consolidating two companies into one generate benefits for investors or just put money into the pockets of managers and advisers?

WHY ARE TRUSTS MERGING?

According to the latest research by the Association of Investment Companies, the current discount to net asset value across the trust sector is the widest it has been since December 2008 when, as the industry body puts it, ‘the world was in the depths of the global financial crisis.’

Annabel Brodie-Smith, AIC communications director, says: ‘History shows us that current discounts could represent a buying opportunity. When discounts were last this wide at the end of 2008, the average investment company returned 39% over the next year and 119% over the next five years.’

For sub-scale trusts, merging with or taking over another similar investment company means a bigger pot of assets and the chance to reduce operating costs, which in turn means they can offer lower fees to appeal more to retail investors, as well as in theory an increase in the liquidity of their shares thanks to a bigger investor base.

On 8 November, Picton Property Income (PCTN) confirmed it was in talks regarding a possible all-share merger with UK Commercial Property REIT (UKCM). On the eve of the announcement, both stocks traded on a 31% discount.

Some investment management firms are taking the initiative themselves, putting together similar trusts and funds within their own stable.

Since the start of the year, FTSE 250 asset management group Abrdn (ABDN) has been reshaping its business, selling off its European private equity division as well as reorganising its investment trust offering.

This has included merging Abrdn New Dawn with Asia Dragon Trust (DGN), both of which traded on discounts of more than 10% before the transaction was proposed.

Abrdn Japan, which traded at a 15% discount to NAV, was recently folded into Nippon Active Value (NAVF). There is also a proposal to merge Smaller Companies Income Trust (ASCI) with Shires Income (SHRS).

EXTERNAL PRESSURE MOUNTING

The urge to merge is also being driven by activist investors, one of the largest being City of London Investment Group (CLIG) which specialises in buying unloved closed-end funds whose shares trade at a big discount.

In May of this year, City of London’s head of corporate governance Simon Westlake called on investment trust boards to narrow their discounts to ‘encourage a thriving sector’.

Westlake suggested trusts offer their shareholders a return of 25% of their capital at net asset value if the manager has done a bad job. ‘It is a fair deal for a manager who still has three-quarters of a portfolio to run, and for long-term shareholders, and will make shares more attractive and part of a discount control package.’

On the subject of consolidation, he added: ‘We want to see more mergers, but we are disappointed that some funds that need to merge are leaving it too late and casting around when they are then too small for a prospective partner to justify the prospectus costs.’

Joe Winkley, head of investment trusts at Winterflood Securities, said the wide levels of discounts were creating a situation where ‘a number of investment trusts need to look at themselves and whether they have a future’.

MIXED TRACK RECORD

One of the most high-profile fund mergers of the last few years was that of Scottish Investment Trust with JPMorgan Global Growth & Income (JGGI).

In June 2021, the board of Scottish Investment Trust undertook a review of fund management arrangements after the company switched tack to a radically contrarian investment approach in 2015 which led it to underperform the MSCI All Country World index in total return sterling terms over the following five years.

As a result of the review, the board decided the ‘most compelling outcome’ for Scottish Investment Trust shareholders was a combination with the JPMorgan trust to create a company with more than £1.2 billion of net assets.

Part of the justification for the combination was the fact the JPMorgan trust had returned an annual 14% in the five years to 30 September 2021, beating the MSCI All-Country World index in sterling by 1.7% per year on average.

The good news for shareholders is that in each of the last two years the combined trust has grown its net asset value by at least 4% more than the benchmark, and now has almost £2 billion of assets and a five-star rating from Morningstar.

Not all mergers are marriages made in heaven, however. Three years ago, Perpetual Income & Growth, a former Invesco trust, merged with the Abrdn-managed Murray Income (MUT) to form a £1 billion company with lower costs and greater liquidity.

So far, the result has been disappointing with a three-year share price return of 7.4% and a net asset value return of 8.3% against around 16% for both metrics for the trust’s peer group and a current discount of 8.3%.

Nor is merging necessarily plain sailing, even when there is a strong commercial logic.

In August of this year, GCP Asset Backed Income (GABI) announced it had agreed heads of terms with GCP Infrastructure (GCP) as part of a plan by investment manager Gravis Capital to create ‘a more sizeable infrastructure and real asset debt vehicle, with greater secondary market liquidity and the ability to return capital to shareholders while offering the potential for a re-rating over time’.

Subsequent to the combination there were plans to merge with RM Infrastructure (RMII), but barely a month after the initial announcement the deal fell apart due to opposition from shareholders in GCP Asset Backed Income, who opposed the manager’s plans and militated for a continuation vote, which is now due to take place in May 2024.

WHICH TRUSTS ARE IN THE FRAME?

Many sub-scale trusts have survived a continuation vote in the last couple of years only for their shares to continue lagging their benchmark or their net asset value, therefore it’s worth asking which companies could be part of the trend towards consolidation.

Using data from the AIC we have picked out seven trusts worth approximately £100 million or less, all of which are trading at a discount to net asset value and all of which have a three-year performance record (see table).

While a persistently large discount to net asset value might on the face of it warrant a discussion about merging, performance – absolute and relative to the sector – needs to be considered.

Henderson Diversified Income (HDIV) recently agreed to merge with Henderson High Income (HHI). The next trust from the Janus Henderson stable to seek a new partnership might be Henderson Opportunities (HOT), tiny at just £69 million and lagging its benchmark on a three-year basis.

Rights & Issues (RIII) is also on our table – earlier this year it appointed Jupiter as its new investment manager after its long-standing manager Simon Knott retired. Jupiter will certainly want to find a way of increasing assets under management and merging with a similar trust could be a logical move.

DISCLAIMER: Daniel Coatsworth who edited this article owns shares in JPMorgan Global Growth & Income

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