Consolidation risk is going through the roof for investment trusts. The industry has been hit by adverse market conditions, leaving the whole sector trading at wide discounts to net asset value (NAV).
To counter this, a number of vehicles have decided to merge to benefit from economies of scale (more money means more fee revenue). The latest example is Tritax Big Box, a real estate investment trust (REIT), that agreed yesterday to merge with UK Commercial Property.
It is part of a trend: four merges took place with further four announced due to take place this year, according to the Association of Investment Companies (AIC).
Where merger is not an option, trusts are choosing to close their doors and wind down. There were eight such examples of this last year.
Hawksmoor’s Ben Mackie told Trustnet that this phenomenon is the only solution for the industry, which must shrink to survive.
“You’ve got to shrink to win, which means less supply. If a trust is trading at an entrenched discount, can’t grow, is sub-scale and mimicking what could be done in an open-ended fund, then what's the point?,” he said. “Less supply has to be a good thing for the sector that remains”.
But where does this leave investors? How should they react when one of the trusts they hold in their portfolios is going through a corporate action?
Below, Laith Khalaf, head of Investment analysis at AJ Bell, offers some guidance.
When trusts close
If a trust is winding up, it becomes a forced seller of its assets – the costs of which are borne by the shareholders. Ultimately, investors will have to find a new destination for their money, but there could still be money to be made if they are patient and don’t jump ship early.
“If the trust is trading at a substantial discount, it may be beneficial to wait for the assets to be sold and the cash returned, as this could well be done at a price nearer to the NAV,” Khalaf said.
When trusts merge
When trusts merge, it’s a matter or reassessing the new investment proposition with a critical eye as if starting with a blank sheet of paper.
Khalaf would look at the merged trust as a completely new holding, where investors should ask themselves questions such as ‘do I like the manager?’ ‘Am I happy with the charges and the investment proposition?’ All this information should be easily available to them in the announcement.
“The answers may or may not be the same as they were before the merger, but either way they are worthy of scrutiny,” the analyst said.
“Ask yourself if you would be keen to invest in the trust if you didn’t already have a holding in it as a result of the merger. If not, then it makes sense to reinvest your money in a fund or trust you have more confidence in.”
Tax considerations
Investors could be liable to pay capital gains tax if they receive cash or redeem the profits made by a merging or closing trust that was held outside of a SIPP or ISA, or if they decide to sell out, which counts as a liquidation, whose gains are potentially taxable.
This is subject to personal circumstances, but a larger-than-usual tax bill can be avoided by transferring some of the holding to a spouse or civil partner beforehand.
“That way you can use two capital gains tax allowances, and there may also be a benefit if they are a lower earner, as higher rate taxpayers get charged CGT at a rate of 20% on gains from shares, whereas this is only 10% for basic rate taxpayers,” Khalaf concluded.