Investment trust boards need to improve their independence, increase diversity and produce better disclosure around responsible investing, according to Quilter Cheviot, the wealth management arm of Quilter plc.
The firm published a range of recommendations after meeting chairs and non-executive directors of 41 equity investment trusts.
First is that Quilter Cheviot expects boards to be independent and diverse, to have the right skillset as well as the ability and willingness to challenge the investment adviser when necessary.
It also wants trusts to provide pertinent responsible investment disclosures with real-life examples and details on how a trust integrates environmental, social and governance (ESG) factors in its investment process.
Quilter Cheviot provided the 41 equity investment trusts with a green, amber or red rating on the three criteria, with just three investment trusts getting a green rating for each category and two a red rating across the board.
The wealth manager has escalation plans for trusts that do not show signs of improvements in the coming years, with measures including voting against the chair or other non-executive directors as well as voting against adviser representatives.
Gemma Woodward, head of responsible investment at Quilter Cheviot, said: “The investment trust sector is far from homogenous, but there is in our view some common themes where there is room for improvement.
“While we are mindful that the regulatory landscape and shareholder expectations are constantly changing and what looked good a couple of years ago has now perhaps lost some of its shine, it is important these improvements are not ignored.“
Quilter Cheviot intends to monitor outcomes over the next three years as it expects that change will be incremental. Yet, it stressed that it will be in touch much sooner with investment trusts where red areas of concerns have been identified.
In the report, the wealth manager said: “In the most serious cases we have already escalated our engagement with a formal letter to the board indicating that unless the situation is remediated, we will be voting against management at the next shareholder meeting.”
Board effectiveness was the category with the highest percentage of green rating, with 70% of the equity trusts receiving this rating. More than 60% of the boards also received a green rating for composition and effectiveness.
Disclosure was the most frequent amber factor, with 82% of trusts receiving this rating. Quilter Cheviot said that it is reflective of the lack of voting rationales or engagement examples.
Seven trusts received a red rating for board composition, which is the factor that had the greatest number of red ratings. The most common reasons were because the board was not meeting the UK gender targets, had non-independent directors or had one or more directors serving over the recommended tenure of nine years without plans to resolve this issue.
Quilter Cheviot highlighted that trusts with a smaller market capitalisation did not seem to be negatively impacted by their size in the rating performance. In fact, trusts with a market cap of more than £2bn tended to do worse for board composition and effectiveness.
The wealth manager added that trusts investing in emerging markets and Asia have outperformed in all three areas, which could be due to the greater severity of ESG-related risks and opportunities in these regions.
The Association of Investment Companies (AIC) welcomed Quilter Cheviot’s report, highlighting the importance of shareholder engagement for good governance, but said that improvements in the sector are already ongoing.
Annabel Brodie-Smith, communications director of the AIC said: “The report has highlighted Quilter Cheviot’s specific concerns about board composition but it’s important to recognise that investment companies have made significant progress in this area in recent years.
“Now 40% of investment company directors are female, meeting the FTSE Women Leaders target. Of course, there is more work to do, particularly on ethnic diversity. The AIC is encouraging more people to consider becoming investment company directors. We have launched a website, Pathway and are participating in seminars to widen the pool of candidates.”
Quilter Cheviot added it has already seen some positive outcomes with trusts it has engaged with. For instance, one trust has confirmed it will expand the disclosure of stewardship activities in its next annual report following Quilter Cheviot’s engagement late last year.
Woodward added: “We have seen some signs of improvement already, but clearly, as some comments from those chairs we questioned suggests, there is a way to go in some cases.
“Ultimately, we want to work in partnership with the trusts where we are shareholders on behalf of our clients, to ensure that the sector keeps pace with expectations and regulations and ultimately produces good investment outcomes.”
Quilter Cheviot will focus on private equity investment trusts in the next phase, before moving on to the infrastructure and real estate sectors.