A win for investment trusts: how scrapping cost disclosures could boost the sector

The investment trust industry celebrated a small but crucial regulatory victory last week – and one that may have consequences for investors. The Labour government said it would scrap the cost disclosure rules that have acted as a major break on wealth management and institutional buyers of investment trusts over the past two years. That could be good news for private investors in the sector.

What’s the story?

The problem had arisen because the EU’s Priips and Mifid directives effectively forced investment trusts to double-count their costs. For price-sensitive wealth managers, using investment trusts inflated the costs they needed to report to customers at a time when many were competing with low-cost alternatives. Many simply chose open-ended equivalents, leaving parts of the investment trust sector languishing with little demand. That pushed discounts out.

The Treasury and Financial Conduct Authority have now said that London-listed investment trusts will be exempt from the regime, and new UK disclosure rules will come into force in the first half of next year. In the meantime, trusts will not be required to disclose any costs.

Richard Stone, chief executive of the Association of Investment Companies (AIC), says: “It’s good that the Treasury and FCA have recognised that the current cost disclosure regime is not working. The AIC has lobbied tirelessly on this issue and it’s encouraging that the Labour government has acted so swiftly.

“We look forward to working with the FCA as it consults on the new Consumer Composite Investments (CCI) regime. It’s vital that these new rules recognise the unique characteristics of investment companies, permanently end misleading cost disclosures, which distort the market, and enable investors to make better informed decisions.”

What does it mean for investors in investment trusts?

The cost disclosure rules had weighed on demand for many investment trusts, particularly those popular with wealth managers. These were often areas where there were few open-ended equivalents, or where liquidity constraints made investment trusts a more appropriate option – infrastructure, private equity or property, for example. In some cases, these were trusts that were also hurt by rising interest rates, and it became difficult to disaggregate the two. Nevertheless, it was clear that the cost disclosure rules were unhelpful.

Will the change in the rules move the dial? At the margins, it probably will. Christian Pittard, head of closed-end funds at abrdn, said the move could bring back pension funds and wealth managers to the sector and revive investor demand. The move comes at the same time as interest rate cuts, and the combination of these two factors appears to be narrowing discounts from their lows already.

The problem has been particularly evident in certain sectors and it is where the early moves have been most obvious. A number of the popular infrastructure trusts, for example, have seen discounts move in by around 10% from historically wide levels. Some of the private equity trusts have also started to recover.

What about Elite Rated investment trusts?

The funds we select tend to be larger and more liquid options, such as City of London Investment Trust, Global Smaller Companies Trust or Scottish Mortgage Investment Trust. These are held widely by private investors and have been less affected by any withdrawal of demand as a result of the cost disclosure rules.
This is deliberate on our part. We prefer trusts that are less vulnerable to a single type of shareholder. The discount for the City of London Investment Trust, for example, varies little, having traded in a range between 1% and -3% over the past year. A share buyback programme keeps it in check. The discount for Scottish Mortgage Investment Trust has also been very stable over the past six months.

Where it might make a difference is in some of the smaller, niche and single sector trusts. Trusts such as Baillie Gifford Shin Nippon has seen its asset class substantially out of favour, as small and mid-cap Japanese equities have failed to keep pace with the rally in their large-cap peers. It has moved from trading at par, or even a small premium, to a 13% discount*. The cost disclosure change may not matter as much as the revival in Japanese smaller companies, but it means there are no barriers to a recovery in the trust’s share price when it happens.

Read now: Our in-depth guide to Baillie Gifford Shin Nippon

The same might be true for Schroder British Opportunities, which has suffered from the general unpopularity around smaller companies. It now trades on a 28% discount* to net asset value, but this has come in from around 35% early this year, and may have further to narrow. Revived interest from wealth managers could move the dial.

It may even be true for other out-of-favour areas. We’d put Murray Income and Fidelity Special Values in that bracket as well. Although both funds are strong performers among their peers, both have seen discounts drift out as investors have overlooked the UK. Cost disclosure won’t be the swing factor for these trusts, but it should help create demand at the margins.

It may be an optimistic take, but there is another encouraging factor in the swift change in the rules. This problem has been bubbling under the surface for some time, struggling to command the attention of government. The rapid change in the rules may also suggest that the new government recognises the importance of capital markets to the overall health of the economy, and the role the investment trust sector can play in that.