Investment trusts are charging unfair fees, according to Hawksmoor Investment Management’s Ben Conway.
Most fund managers and investment advisers base their fees on the net asset value of investment trusts’ underlying portfolios, but for trusts holding hard-to-value private assets, those valuations are subjective and can fluctuate wildly, he argued.
Conway, who is Hawksmoor’s chief investment officer, thinks it would be fairer for all investment advisers to charge fees based on a trust’s market capitalisation to align their interests with shareholders.
“Calculating fees as a percentage of a valuation figure that is so clearly subjective is simply a nonsense and creates horrific alignment issues for shareholders,” he stated.
Investment trust fees have been a hot topic of late, following their recent exemption from European Union cost disclosure rules. Conway’s argument concerns an unrelated point, however – whether charges themselves are fair, not how they are disclosed.
To illustrate his point he described two investment trusts whose portfolios have been written down recently – Gresham House Energy Storage and Digital 9 Infrastructure – causing shareholders to wonder whether the investment managers have been charging fees based on inflated valuations.
Gresham House Energy Storage (GRID) announced a material write-down to its NAV on 9 September after replacing one of the two third-party consultants it uses to calculate its NAV. The new firm used lower revenue forecasts for the trust’s batteries than the previous consultant.
“The fact that GRID switched from one provider to another – both doing the same job, looking at the same information and yet coming up with different forecasts – shows how subjective this analysis of revenue forecasts is,” Conway said.
“In GRID’s case, the natural question for shareholders to ask is: have they been overcharged during the period when a more aggressive provider of revenue assumptions was used?”
The board of Digital 9 Infrastructure, meanwhile, announced a provisional NAV of 45p per share on 6 September – a 43.2% reduction from the December 2023 NAV.
The trust’s assets rely on future capital investment to fund their expansion, making them hard to value. “Fees on an NAV that is subject to such a huge and sudden revaluation is just not acceptable,” Conway argued.
“For any asset where there is scope for subjectivity or sudden revision due to external factors, fees must be levied on market cap,” he continued. Otherwise, “the scope for misalignment between the investment adviser and the shareholder is too great”.
Furthermore, with many trusts trading at wide discounts to their net asset values, the returns experienced by shareholders are intrinsically linked to the trusts’ market capitalisations and share price – but bear a more distant relationship to the underlying portfolio’s NAV.
Three-quarters of investment trusts base their fees on NAV. This is a bigger problem for trusts invested in alternative assets given that their NAVs are calculated less frequently and subject to greater mark-to-market revisions. Nonetheless, Hawksmoor would like to see all trusts switching to fees calculated on market cap, even equity-oriented trusts whose portfolios are easy to value, to ensure alignment with shareholders.
Currently, 8% of investment companies (excluding venture capital trusts) charge on a market cap basis, according to the Association of Investment Companies (AIC).
Bellevue Healthcare (BBH) is one example, said William Heathcoat Amory, managing partner at Kepler Partners. "We like this feature, as it incentivises the manager to see the shares trade close to NAV and aligns their interests more with those of shareholders. BBH’s fee of 0.95% is also lower than the 1.25% weighted average for the AIC Biotechnology & Healthcare sector and there is no performance fee," he said.
James Carthew, head of investment companies at QuotedData, has a different perspective. "Our stance has always been that the best fees are based on the lower of market cap and net asset value," he said. Just 4% of investment trusts do this currently, according to the AIC.
Meanwhile, WhiteOak Capital Management, which manages Ashoka India Equity and Ashoka WhiteOak Emerging Markets, has pioneered another approach. It does not charge a fixed management fee at all but instead levies a performance fee on a three-year cumulative alpha basis.
Founder Prashant Khemka said: “We only get paid if we outperform. The alignment of interest is strong because we can't just sit on our laurels and expect to get paid.”