Over on Monevator Moguls [1], we’ve been kicking the tyres on several investment trusts during the past year.
There was a big dislocation [2] in the closed-end fund market when interest rates soared in 2022. Even the beloved ‘dividend heroes’ went cheap in the sales.
Elsewhere, infrastructure trusts that had previously traded on giddy 20% premiums to net assets (NAVs) fell to that level of discount. This 20% premium to 20% discount swing was independent of any move in their underlying assets. Some even reported rising NAVs!
Meanwhile you could drive a truck through the discounts on private equity and venture capital trusts. The most heavily-discounted traded at 40p on the (purported) £1 or less.
All told the average trust discount reached 19% last year – a level not seen since the financial crisis.
Even after a mini-rally, the average discount is still in double-digits.
Cheap for a reason(s)
So, fill your boots, active investors [3]?
Well perhaps – with all due caveats. And assuming you’re a naughty type [3] who understands the risks and hassles as well as any potential rewards.
But should you decide to wade into this Sturm und Drang intent on bagging a bargain, your favourite investing platform/broker may have other ideas.
The reason why harkens back to why some investment trusts may have sold off quite so severely.
99 problems and a glitch ain’t one
The woes of the investment trust sector is multi-factored if not omni-shambled.
The bear market of 2022 [4] blew the trumpet on the start of the carnage as interest rates rose. The unloved UK market [5] tossing everything into the bargain bin didn’t help either.
Investment trust discounts and premiums [6] being buffeted around by supply, demand, and the emotional state of the market is nothing new.
But in this particular sell-off, trusts have also faced local turbulence that’s sent some into a tailspin.
For a start there’s the Consumer Duty [7] regulations of 2023 that might make advisors more wary of exposing their clients to the extra complexities of investment trusts – and themselves to legal liability.
Wealth manager consolidation [8] may also have forced the selling of certain trusts. It’s also left some trusts too small [9] for the now-bigger managers to bother with.
Finally new-ish cost disclosure rules [10] – derived from two pieces of legislation we retained after leaving the EU1 [11] – seem to have been implemented in a particular obtuse way in the UK.
According to the investment trust industry, this has put trusts at an unfair disadvantage versus other kinds of funds.
How much?
On the latter point, even the House of Lords [12] has criticised the way the Financial Conduct Authority (FCA) has implemented the cost disclosure requirements.
The Financial Times [13] neatly summarises the situation:
The way the FCA interprets these pieces of legislation compels investment trusts to report their costs in the same format as open-ended funds.
The result is that investment trusts look more expensive than they actually are.
[For instance, in the accounts of the Temple Bar investment Trust] the ongoing charge – an expression of the company’s management fees and operating expenses – is 0.56%.
But if you look at the Key Information Document, devised by regulators to help investors make more informed investment decisions, the annual ‘cost impact on return’ is 1.48%; and if you exit after five years you’ll pay £712 in total on an example investment of £10,000 […]
These metrics are fine for open-ended fund fees, which deduct management fees when the daily unit price is updated.
But for investment trusts, fees and costs simply reduce the net asset value that an investor has a stake in by owning shares. Investors will also pay broker trading and stamp duty fees to own those shares.
The investment trust industry says the onerous cost disclosure regime has put off both retail and professional advisors, which has further weakened demand and driven discounts even wider.
Please sir, can I have some more?
The FCA acknowledges [14] there’s a problem with cost disclosure. It’s apparently working on a long-term fix.
Indeed the potential for things to get better is another siren call that’s attracted me to the sector.
After all, one way to (try to) profit as an active investor is to head in the direction that everyone else is running from.
And if institutions are dumping assets for non-economic reasons then consider my interest piqued.
However to profit from any David vs Goliath heroics, we must be able to implement our cunning plans.
That is: we actually have to buy the things.
And that isn’t always easy when regulators and platforms are ‘protecting’ everyday investors from getting into some of the hairier trusts.
All’s fair in love and discounted investment trusts
For instance CityWire reported in April on how AJ Bell was restricting clients from buying shares in the investment trusts Chrysalis (ticker: CHRY; I hold) and Bluefield Solar Income (ticker: BSIF).
AJ Bell did this following ‘fail’ assessments in a fair value review conducted by its external consultant, 360 Fund Insight.
CityWire reports [15]:
Investors could phone through a transaction and still pay the online charge of £5 rather than the normal phone fee of £25, a spokesperson for the firm said.
Customers of AJ Bell complained they had also been prevented from buying Digital 9 Infrastructure, Cordiant Digital Infrastructure, and Amedeo Air Four Plus after those too failed the assessment.
Investors are furious they are being prevented from buying closed-end funds trading on wide discounts that they regard as good value, and believe the low share prices offset any potential concerns over performance and costs.
And no wonder! What’s the point of enabling active investors to trade securities on your platform if you’re going to overrule their own assessment of value with one you prepared earlier?
I also don’t understand why clients could phone through orders, but not make the deals online? Perhaps a broker on the other end probes their suitability (or sanity). Better answers in the comments, please.
As for the ‘fair value’ issue though, this appears to be fallout from the Consumer Duty regulation I noted earlier.
Fair dealing
Platforms and brokers say Consumer Duty means they must alert customers who are at risk of poor returns and help them to make better decisions.
According to CityWire, price, performance, leverage and liquidity are all factors determining whether investment trusts are regarded as ‘fair value’.
However you don’t need to be Warren Buffett to understand those very same factors could make a trust potentially cheap, and be what’s attracted bargain hunters in the first place.
Moreover if I’ve got a longer time horizon than whoever sells me their shares – and/or if I’m happier to put up with liquidity issues or some other drawback – then my idea of ‘fair value’ may be legitimately different from a sellers’ – or even from a platform’s hired consultant.
The point of markets is that opinions differ. That is how we really do arrive at fair value.
It seems unlikely the legislation means to funnel everyone into a consensus-satisfying Nasdaq tracker fund – or whatever else is the winning investment du jour.
But a glib reading could suggest otherwise.
Set up to fail
AJ Bell is not alone in protecting investors from potential money-making opportunities. It’s happening all over the place.
For example the same CityWire article notes:
Hargreaves Lansdown has also restricted investors from buying Digital 9 Infrastructure, Cordiant Digital, and Amedeo Air Four Plus until they pass a questionnaire showing they have the understanding of ‘complex investments’.
While Cordiant and Amedeo are listed on the London Stock Exchange’s specialist fund segment, Digital 9 is not – though it is still viewed as ‘complex’.
Closer to home, Monevator Moguls member Mirror Man found a ‘Complex and Levered Product’ label being applied by Interactive Brokers to various investment trusts, hindering them from buying shares even in a giant trust like Brevan Howard’s £1.3bn BH Macro. (Ticker BHMG; I own).
In the Monevator comments [16], Mirror Man explained the platform won’t allow them to add to their existing holding of BH Macro, though it will let the shares be sold.
To buy more, Mirror Man must pass a test covering stuff such as ETNs, warrants, discount certificates, and leveraged ETFs, by answering questions like:
Assume a warrant on ABC share has a strike of EUR 40.00 and an exercise ratio of 0.1. The share is trading at EUR 45.00 and the warrant at EUR 0.70, resulting in a leverage of 6.4. If the share price were to increase to EUR 50.00 while the time value of the warrant remained constant, which of the following statements is true?
But I’m here to tell you nobody should need to be able to answer such questions to assess whether they should have money invested in BH Macro.
That’s because as a private investor, having such knowledge won’t help you judge the trust’s virtues – or otherwise.
What was the question again?
BH Macro is essentially a black box from the outside when it comes to the complexities of its trading models (though it does disclose plenty of other information in regular updates to the market).
Its fees are high, too.
These are two very good reasons to be cautious before investing in this trust.
In contrast, understanding how warrants are priced won’t help you assess the pros and cons. No more than I need to know how a jet engine is serviced in order for me to book the best flight to New York.
More relevant questions would focus on customer-specific issues. They might assess your general investing know-how, your level of experience in terms of time and range of investments, your capacity to take losses – and, crucially, your willingness to sign away any liability should losses occur.
Many readers will be familiar with the ‘sophisticated investor’ assessments sometimes required when investing into unlisted companies. Those seem to me more fit for purpose.
It’s behind a sign-up wall, but CityWire published [17] the answers to a Hargreaves Lansdown questionnaire concerning complex products. This test – or at least the portion CityWire shared – does at least seem more in the ‘sophisticated investor’ vein than esoterica about trading instruments.
Anyway Hargreaves reportedly pushed back, saying that investors being able to access a cheat sheet could provoke the ire of the FCA.
So CityWire removed them but it left the quiz up, with heavy hints about how to answer.
Who is protecting who?
Why help Hargreaves’ customers get through their unasked-for homework?
I’d echo the CityWire journalists, who wrote:
We share the frustration of readers about the classification of some investment companies and trusts as ‘complex’, and the assumption that their investors need protecting.
The Financial Conduct Authority’s consumer duty rules require share-dealing platforms to flag ‘complex instruments’, which they can implement in their own way.
While Hargreaves requires you to pass the questionnaire, AJ Bell, Interactive Investor and Fidelity simply ask investors to certify that they are aware of the risks.
To my mind this cross-platform subjectivity is another unjustifiable aspect to the whole business.
It would be one thing if there were a centralised list of what trusts were in or out for retail investors. I’d still argue against such a mandate, but at least there’d be consistency.
But as things stand I can – and have – bought BH Macro on one of my platforms without any fuss, while arbitrarily Mirror Man cannot on theirs.
Does that seem right?
Of course being a person whose paranoia [18] has me using half-a-dozen different platforms, I suppose in practice this ‘will they, won’t they?’ uncertainty works for me, compared to a blanket all-platform banning from on high.
That’s because I can usually find what I want with one of my brokers.
Nevertheless a simple approved list of trusts would be more logical. The current approach smacks of platforms playing chicken – if not arse-covering.
When you come at the king…
Talking of illogical, last summer even saw [19] Fidelity suspend investments into RIT Capital Partners (ticker: RCP, and yes I hold). This is the OG granddaddy of wealth-preserving investment trusts – hitherto seen as a prudent place for middle-aged duffers to park the proceeds from daddy’s estate sale.
True, RIT has struggled recently as the market has become wary about unlisted holdings. RIT has a chunky (and hitherto profitable) allocation to private companies, and its discount blew out to near-30%.
But again, should platforms be assessing the risks and rewards on offer with such a security? Let alone trying to assess via questionnaires whether their customers could do the job of investment trust employees should the latter come down with the lurgy?
As Mirror Man said in their comments: “I want my broker to provide me with a service (order execution), not masquerade as a financial regulator.”
As things stand it’s possible that by making it harder to invest in trusts, platforms are exacerbating the discounts, given that everyday retail investors are the natural buyers of a trust like RIT Capital.
Passive aggressive
Incidentally, any passive investors who made it this far might be thinking it’s all another reason they’re best out of active investments (which most will be [20]).
Yet the very same regulations also prevent [21] you from buying most US-listed ETFs on the UK platforms.
I know there are ways around this, such as if the ETF has issued a Key Information Document (KID).
Individuals who can declare themselves as professional investors can buy non-UCITS ETFs, too.
But again, anyone can happily buy thousands of other US assets – in ISAs and SIPPs even. Dodgy meme stocks are no problem. Is restricting access to (sometimes larger and cheaper [22]) US ETFs really logical?
Happily it seems the regulator is having second thoughts about this one.
From ETF Stream [23]:
ETFs domiciled in the US could be granted equivalence under the UK government’s Overseas Fund Regime in a move that would open the market to US-listed ETFs.
The Financial Conduct Authority launched a consultation [24] with asset managers last December on how products should be recognised under the post-Brexit framework.
The UK government granted equivalence [25] for all UCITS vehicles in the European Economic Area (EEA) in January, with US-listed ‘40 Act’ ETFs also being considered.
Any move would need to be approved by the UK Treasury deeming the regulatory regime for the overseas fund to be equivalent to the UK.
US-listed ETFs are not currently available for sale under EU law as they do not publish certain documents required by the European and Securities Markets Association.
Finally, potentially, a Brexit benefit!
It’d be a win-win for all of us.
Who’d be a regulator?
Honestly I do have sympathy for the regulators – and for the platforms trying to keep up with them.
And I fully understand the push to make the financial services sector one where service is more for the benefit of customers than for employees.
The disinfecting sunlight cast upon high-fee financial advisors [26] in recent months is overdue, for example.
On the other hand, regulators shouldn’t stop people who know what they’re doing – or who are willing to accept the consequences anyway – from spending their money as they see fit.
And I think the same should hold for over-zealous and/or over-cautious platforms interpreting how the regulatory wind is blowing.
Consider the FCA’s semi-reversal on Bitcoin ETFs – vehicles now running perfectly smoothly in the US.
The FCA’s revised position is [27]:
These products would be available for professional investors, such as investment firms and credit institutions authorised or regulated to operate in financial markets only.
But is barring access to Bitcoin ETFs the best way to protect retail investors?
Think about the long history of crypto platforms being looted or otherwise falling over. The booms and busts of alt-coins. The legions of crypto grifters pumping and dumping daily across social media.
Not to mention the mishaps that can occur when people attempt self-custody of their own crypto assets – including sending millions of pounds worth of crypto to landfill [28].
There are even micro-cap Bitcoin miners listed on the AIM market which are freely available for trading.
You can have at all those, no problemo. But apparently only professionals can be trusted to put £1,000 into a bog-standard Bitcoin ETF.
The fault is in ourselves
Running a blog about personal finance and investing, I see all the scammers and shysters.
Indeed I spend the best part of an hour every day wading through their spam in the Monevator comments and email.
Also, for better or worse our society has moved towards a compensation culture.
Many people now expect to be bailed-out when their decisions don’t work out – but left well alone when they do. It’s hard to square.
So regulators and platforms surely have a difficult time of it.
Still, given all the straight-up larceny around, I don’t see that restricting informed and hands-on investors from buying shares in legitimate companies should be any regulator’s top-priority.
Investment trusts have a duty as listed businesses to accurately report their activities to investors. All information properly required should be made available. And platforms should flag it where appropriate.
Fine – if we must have a checkbox with links to the downside and the risk of ruin then on our heads be it.
Companies shouldn’t lie to us or wantonly mis-sell products. Regulators can valuably tackle those issues.
But frankly, if after being given the relevant data somebody wants to invest their money with a legal but ‘reassuringly’ expensive high-fee advisor say – perhaps because they like glossy brochures and feeling special – then that’s their business as far as I’m concerned.
And given that, I obviously believe we should also be able to buy whatever (legal) securities we want.
Regulation versus prohibition
If after being given the appropriate warnings I want to buy a triple-levered ETF shorting [29] the Nasdaq then let me.
Just like if I want to buy a value pack of ten beers and 40 fags for the evening.
It’s not advisable, but it’s my choice.
I’m not making some specious point here about enabling UK investor’s money to ‘support the London Stock Exchange’ or ‘channeling money into productive investment’.
I just think it’s a matter of basic morality and freedom in a capitalist system.
Sure, have gatekeepers for mainstream products.
But don’t let them become wardens hampering the minority of us engaged investors who actually do our research – and who are ready to live with the consequences.
What do you say readers? How would you regulate if you were given the awkward chalice? Let us know in the comments below.
- Mifid (Markets in Financial Instruments Directive) and PRIIPS (Packaged Retail Investment and Insurance-based Products [↩ [34]]