What do 2022 and 1868 have in common? Both were politically tumultuous years, with Britain witnessing three prime ministers in each: Boris Johnson, Liz Truss and Rishi Sunak versus the Earl of Derby, Benjamin Disraeli and William Gladstone.
I will leave readers to ponder their relative merits in a game of UK Prime Minister Top Trumps. Truss' key strength would obviously be her vocal support for the UK cheese sector.
The year of 1868 also saw the launch of the Foreign & Colonial Investment Trust, established “to give the investor of moderate means the same advantages as the large capitalists in diminishing the risk by spreading the investment over a number of stocks”.
Since then, the UK-listed investment trust sector has flourished, with 362 investment companies and £267bn of assets today, according to the Association of Investment Companies.
But in 2022, we saw the culmination of years – and multiple layers – of regulatory missteps which have served to start a mass exodus of institutional and retail investors from the sector.
This regulatory coup de grace for the investment trust sector was borne of a desire to increase ‘cost’ transparency for investors. However, the impact on clarity has been akin to pointing the overflow pipe of a sewage treatment centre at a chalk stream.
The issue is somewhat arcane but nonetheless devastating. UK investment trusts – and it is only the UK that has interpreted EU rules this way – are required to report ‘ongoing costs’, as though they were exactly the same as open-ended funds.
Units in open-ended funds are bought and sold at NAV (net asset value) and fees/costs are deducted from an investment throughout its holding period, hence an ‘ongoing cost ratio’ makes perfect sense.
Investment trusts, in contrast, issue shares, which are then traded on the secondary market – and no fees/costs are deducted from your shares at any point during ownership. Operational costs and expenses for any listed company, including an external manager’s fees, are already discounted in the share price.
Retail investors are therefore given the misleading impression that, after purchasing shares in a trust, they will be paying yearly ‘ongoing costs’.
Meanwhile, institutions and wealth managers buying investment trust shares are required to aggregate the ‘costs’ of those underlying vehicles on top of their own charges, thereby overstating what clients are actually paying (and making themselves look uncompetitively pricey at the same time).
And before consumer transparency crusaders grab their megaphones, let’s not forget that investment trust management and directors’ fees, audit costs, etc., are all detailed prominently in a variety of places already, including in reports and accounts, factsheets and prospectuses.
Cost disclosures, as currently structured, do the opposite of providing investors with the ‘clear and not misleading’ information that will help them to make informed investment decisions.
Investment trusts also suffer other disadvantageous treatments: regulatory capital requirements and prescribed investor communications.
In terms of regulatory capital requirements, banks and brokers wishing to make markets in investment trusts have been forced to hold twice as much capital than other shares, thereby making them a less attractive market to operate in and reducing potential market liquidity.
This is nonsensical. Investment companies are inherently less risky than single operating companies, being diversified portfolios by nature. That was one of the key raisons d’être of the Foreign & Colonial Trust in 1868. (Here, the penny finally seems to have dropped and changes to this policy are forthcoming.)
And finally we have the universally derided PRIIPS KID (Key Information Document), designed to be ‘consumer-friendly’ but also outright confusing and misleading – and only imposed upon UK investment trusts. Mercifully, the penny seems to have dropped here too and PRIIPS is being repealed in the UK.
The net result of all these measures has been a negative for everyone in the UK. Consumers shun the shares of great investment trusts because they are misled into thinking they actually have to pay to own them on an ongoing basis.
Institutional shareholders avoid investing because it becomes an act of self-harm to own a UK-listed trust whose ‘costs’ must be added onto their own.
And UK PLC misses out on a vital capital flow into key infrastructure, energy transition, social/ healthcare property and early-stage companies via new capital raises.
Much is made of the moribund UK listed market but, in 2021, a quarter of all IPOs were investment companies. Since then, ill-judged cost disclosure rules, and some admittedly powerful macro factors, have served to all but extinguish this bright spark in the UK market ecosystem.
It costs nothing, and risks no consumer harm, to rectify these factors but, if the status quo remains, investors will continue to favour listed companies that aren’t subject to these issues, with no ‘ongoing cost’ fallacy and better liquidity.
And That. Is. A. Disgrace. We should all be very cheesed off about it.
James de Bunsen is a portfolio manager on Janus Henderson Investors’ multi-asset team. The views expressed above should not be taken as investment advice.