Investment trusts are a form of closed-ended vehicle. As such, they differ from open-ended funds in a number of ways. One key variation is the presence of a trust’s board of non-executive (independent) directors. At Square Mile, we consider the board to be one of the greatest advantages of the investment trust structure.
In this short article, Square Mile’s Research Director, John Monaghan, outlines what exactly a board of an investment trust does, and why they are of such importance to the smooth running and effectiveness of this type of investment product.
WHAT IS THE BOARD'S FUNCTION FOR AN INVESTMENT TRUST?
The board’s function of an investment trust is much the same as a board for any publicly traded company. They are responsible for governance and oversight of the fund, to ensure that shareholders’ interests are protected, and that the trust’s performance is in line with expectations.
In practice, that can require their involvement in a number of activities such as appointing, or removing, personnel or setting up the fund’s audit committee to ensure financial matters are handled appropriately. They will meet on average around four to five times a year, though it can be more when required, with separate regular meetings of the audit committee and discussions for remuneration.
Critically, the board plays a crucial role in controlling the discount or premium at which a trust’s shares trade. They have to consider the balance between the supply and demand of the investment trust’s shares, which will affect the level of discount or premium, and act as required.
Often, that will mean they either choose to buy back up to 14.99% of investor shares to reduce any imbalance or, if the trust is trading at a premium, the board may choose to issue new shares instead. However, they can also oversee tender offers, which is similar to one-off buyback, where shareholders sell their shares back to the trust at a specific price. Two other lesser-used price control tools are implementing a different sales and marketing strategy or adjusting the dividend policy. Both can have the effect of decreasing or increasing sellers or buyers for the trust’s shares, therefore influencing its share price.
WHY IS AN INDEPENDENT BOARD SUCH AN ADVANTAGE FOR INVESTMENT TRUSTS?
Boards aren’t involved in the day-to-day management of a trust’s underlying portfolio. They are, however, a huge advantage to investors as they add an extra layer of due diligence and accountability. Plus, their fiduciary duty means that the board has to have all shareholders’ interests front and centre of the decision-making process across all elements of the trust’s operations.
Furthermore, the board also has the ability to smooth income distribution. For investors, this can be of huge benefit, knowing that their income is likely to be less bumpy than with open-ended vehicles. The board’s price control capabilities are highly beneficial to investors too. Not only does it help regulate their shares’ value, but it helps ensure liquidity to reduce risk.
Boards are ultimately, then, a vital component of the governance structure of a trust and can materially help to improve the transparency of a fund as well as its long-term performance.
HOW DOES SQUARE MILE ASSESS THE BOARD?
Given the importance of the board’s function to the overall performance of an investment trust, evaluating the board itself is an integral and essential part of Square Mile’s qualitative process.
Assessing the board requires Square Mile’s analysts to evaluate:
● Its composition
● Its independence
● Individual members’ relevant skill set, experience, and competence
● Its diversity
● Its alignment with shareholders
Additionally, Square Mile’s analysts also investigate the efficacy of the implementation of the board’s discount/premium control measures to appraise how effective the board is or has been. Analysis into the success of the board’s decisions on how to distribute accrued income are also required given the board’s ability to transfer income into a revenue account to augment future dividends.
These board assessments will be conducted in conjunction with the same qualitative assessments Square Mile’s analysts apply to open-ended funds. The process entails regular face-to-face meetings with the manager or managers responsible for running the strategy where a range of factors are considered. They include appraising the team and their environment, philosophy and process, risks, and performance profile, ESG integration and costs. Where deemed necessary, the analysts will also meet with members of the board to discuss issues that may need more oversight.
When assessed together, it is then possible for Square Mile’s analysts to determine their level of conviction in a strategy’s ability to meet its stated objective and whether it merits a rating - of which a deep dive into a trust’s board will always be vital.
Take a look at Square Mile’s rated Investment Trusts.