Fund managers running investment trusts have had a torrid year.
With the pandemic shaking markets, the average discount to asset values — a key performance measure — has widened from a historic low of just 1.3 per cent at the end of 2019, shortly before Covid-19 struck, to around 7 per cent at the end of last month, according to the Association of Investment Companies (AIC), the industry body.
But it could have been much worse — in March, at the height of the market sell-off, the average discount soared to more than 22 per cent, the biggest since the 2008 financial crisis, with individual investment trusts dropping to discounts greater than 30 per cent.
The subsequent recovery has been uneven, a reflection of the range of the 400 or so investment trusts with money in everything from UK shopping centres to Tesla, the electric car company. Trusts are moving towards the end of 2020 with their assets valued at just over £200bn, a little more than the end-2019 total, according to AIC figures.
“In my 29 years, this has probably been the most challenging,” says Job Curtis, longtime manager of one of the UK’s oldest investment trusts, City of London, founded in 1861. Despite the impact of Covid-19, the trust increased its dividend this summer for the 55th consecutive year, but did so by using its reserves to cover 20 per cent of payments — the highest drawdown ever.
The capacity of trusts to maintain or even increase payouts to investors when many listed companies were cutting or axing them has shone a spotlight on the trust business model, and driven a resurgence in popularity with investors.
But dividends are not the only attraction of a financial institution known for its wide diversity and flexibility of purpose.
Flexibility and creativity
Investment trusts were developed in Victorian Britain to help the growing middle classes take advantage of growing, but risky opportunities in far-flung corners of the British empire. By pooling investments, fund managers could limit risk for their clients and make a profit themselves if things went well.
Unlike open-ended mutual funds, investment trusts are closed-ended, so investors can buy and sell shares only by trading with other investors on the stock market. They cannot demand their money back from the fund managers. Equally, their cash cannot be frozen inside a failing fund, as happened last year to open-ended fund investors in Neil Woodford’s flagship Equity Income fund.
This allows investment trust managers to be more daring — in taking on gearing, for example, or focusing on alternative investments. Or to be prudent and build reserves in times of plenty to cover lean years.
Freedom has encouraged creativity. Investment trusts have branched into different directions such as the UK economy, especially smaller companies, rising Asian markets and global infrastructure.
The Covid-19 crisis has highlighted the strengths of investment trusts for investors, such as their ability to provide consistent income, hold unlisted growth stocks and give exposure to alternatives.
Retail investors have been hit hard this year by the marketwide collapse in corporate dividends. UK payouts are likely to have fallen by about 39 per cent for the year, down to just £60.4bn in the best-case scenario, according to analysis from Link Group, an investor services business.
But many investors in trusts have been cushioned from the blow. Some 58 per cent of the 124 trusts that have reported so far this year have increased payouts, according to the AIC, and a further 23 per cent have held them.
More than 19 trusts, singled out by the AIC as “dividend heroes”, have increased their dividends every year for 20 years. Among them is City of London, where Mr Curtis says: “Investment trusts have this structural advantage for income in that they can smooth the experience.”
Acknowledging the challenges involved in steering the company through the pandemic, Mr Curtis adds: “That’s what makes the job endlessly fascinating, the world changes and you have to guide the portfolio through. The sheer number of dividend cuts in the UK has been a pretty tough period. But the fundamental strengths of the structure and core of our portfolio has seen us through it.”
Persistent low interest rates could encourage even more retail investors to go for income-focused investment trusts — especially if Bank of England rates turn negative.
“If people need income, they’re not going to get it from banks,” says James de Sausmarez, head of investment trusts at London-based manager Janus Henderson. As people look to the capital markets instead, “investment trusts have a performance advantage. The fees are good, and the board provides good protection for shareholders.”
The sector’s ‘poster child’
Other trusts have stuck to growth, few with more success than the Scottish Mortgage Investment Trust from the Edinburgh investment manager Baillie Gifford, founded in 1908.
The trust has generated cumulative returns of 674 per cent over the past decade off the back of large, long-term investments in tech stocks like Tesla, beating the FTSE All World index which rose just 191 per cent during that time. The year, the trust is 76 per cent up since March, compared with 24 per cent in the global index.
“2020 is the year of Baillie Gifford,” says Simon Elliott, head of research at Winterflood Investment Trusts. The manager’s flagship trust, Scottish Mortgage, is “the poster child of the investment trusts industry”.
James Anderson, Scottish Mortgage’s manager for over 20 years, bet big on technology more than a decade ago at a time when many investors were still licking their wounds from the dotcom crash.
Mr Elliott says: “Mr Anderson has always said that if and when the next downturn occurs, that Scottish Mortgage would prove to be defensive. This year that’s really come through . . . they’ve been in the right areas of the market.”
Other tech-focused trusts include Polar Capital, up 44 per cent over the past year, and Allianz, which has total returns of 59 per cent, according to the AIC.
Growth-oriented investment trusts are looking beyond Silicon Valley. Last year Baillie Gifford opened its first office outside Scotland, in Shanghai, in a signal of intent. “If you’re not investing in China for growth you’re missing the point,” says Baillie Gifford China fund co-manager Sophie Earnshaw.
Other trusts backing Asia include Schroder’s Asian Total Return, which is up 26 per cent in the past year, and Pacific Horizon Investment trust, which has had a total return of 110 per cent.
If anything, the trend towards Asia is accelerating, as investors look to markets that have weathered the pandemic. “The big trend from October is that investors are turning east,” says Interactive Investor, one of the UK’s largest retail investment platforms. “There are only three investment trusts that are China specialists, and all three appeared in our top 10 last month, which is extraordinary.”
Trusts have long been popular for investing in emerging markets because of their ability to invest in less liquid holdings without fear of rapid redemptions from skittish investors as might hit unit trusts.
That ability puts trusts in a strategic place, managers say, as rapidly growing privately held companies, such as China’s huge Ant Group, show less haste to list, preferring to raise capital from select groups of hungry investors behind closed doors.
A growing divide
With the global switch from public to private markets, some investment trusts are focusing more on alternative assets, in contrast to the traditional focus on public markets. They offer retail investors a way into these alternatives without the large minimum investments required for direct investments in, for example, private equity.
“One thing to remember about the investment trust sector, is that it’s become two sectors,” says de Sausmarez at Janus Henderson. “Traditional investment trusts, and alternatives.”
In 2020’s volatile markets, established trusts proved a haven for many. “In uncertain times, investors have flocked to . . . those large, global generalists that have been serving investors for decades and decades, through world wars, booms and bust, pandemics and the great depression,” says Interactive Investor. “That is certainly what happened in March this year when we went into lockdown.”
Some alternative funds have suffered badly in tough conditions. For example, the DP Aircraft 1 trust, which invests in leasing and selling aeroplanes, a difficult business during the pandemic, trades at a 94 per cent discount.
But others have prospered. Supermarket Income Real Estate investment trust (Reit) investing in supermarket real estate, has outperformed in the pandemic. And the Warehouse Reit has been an extraordinary bet, cashing in on demand for warehouses to facilitate ecommerce, boosted by nationwide lockdowns. Total return is up 22 per cent over the past three years, and the trust trades at a 7 per cent premium.
“It costs double to build a new warehouse than to buy one already built,” says Monica Tepes, investment company research director at FinnCapp, a broking house. “So the trusts market is split between winners and losers. Some trusts were in the right sectors that were not affected by Covid-19, or benefited from it. Others were hard hit — like property funds that invest in restaurants or cinemas.”
New investment trusts are pursuing new trends. Hipgnosis, an investment trust, invests exclusively in music catalogues from songwriters, making returns on residuals for those songs.
In September, The Home real estate investment trust announced plans to launch and invest in housing for the homeless and capitalise on the desire for ESG investment opportunities.
But managers also have an eye open for unfashionable sectors that might return to the limelight. Recently, three trusts — the Schroder Business Opportunities Trust, Tellworth British Recovery & Growth and Sanford DeLand UK Buffettology Smaller Companies Trust — have attempted to raise capital to invest in UK small companies and apply “value” style investing. However, the going was tough — Tellworth and Buffetology both dropped their flotation plans.
“The UK microcap market looks very cheap right now, but just because something is very cheap doesn’t mean that people will want to buy it and that’s a problem,” says Mr de Sausmarez. “If you like small companies, there are trusts already in the market that are sitting on large discounts.”
The small size of many trusts makes institutions wary: they say the large stake they would need in each trust would make their exposure too great. Some 40 per cent of UK trusts have assets of less than £100m, according to London Stock Exchange figures. Only two trusts have a market capitalisation above £10bn — Scottish Mortgage on £14.8bn and 3i Group on £10.2bn.
The industry has been hit by consolidation, as struggling, smaller trusts are rolled into larger ones, something analysts say is likely to continue. Fifteen trusts have announced their intentions to close or merge since August — compared with five over the same period last year.
“More funds are looking to wind down, taking over other trusts, changing what they do or how they do it,” says Ms Tepes. “This normally happens after you see a crisis.”
But that does not detract from the sector’s popularity with retail investors, especially as deregulation in recent years has allowed more people to take control of their finances, notably in pension schemes. Also, the growth of investment platforms has eased investment processes for savers without access to personal wealth managers. Mr de Sausmarez says: “The reliability of investment trusts is a very attractive thing . . . to the self-advised investor.”
Profile 1: Baillie Gifford China Growth
Co-manager: Sophie Earnshaw (with Roderick Snell)
The investment approach: BG China Growth, launched in 1907, focuses on listed and unlisted growth stocks domiciled in China, aiming to hold them for at least five to 10 years.
Key points: Baillie’s decision to open a research office in China, its first outside of Scotland in 110 years “speaks to the importance of China for the firm,” Ms Earnshaw says, pointing to China’s “sheer size and the hunger for the new, and willingness to adopt tech and innovation”.
The ability to invest in unlisted shares has been a boon to the trust, which participated in an exclusive fundraising round for Alibaba’s parent company, Ant Group, in 2018.
The trust argues that UK investors are underexposed to China — which has represented one-third of global economic growth in the past decade. The fund prides itself on building close relationships with selected companies and on looking outside China’s biggest cities for opportunities.
Ms Earnshaw says many companies it holds stakes in had never been contacted by international investors before. “China is so exciting because of sheer scale,” says Ms Earnshaw, who has steered the trust into large holdings in healthcare, electric vehicles and domestic Chinese clothing brands that are expected to grow as China turns away from the West. “You’re starting to see an ecosystem of innovative companies really emerging like what you have in the West Coast of America. It’s something that we’re thinking about a lot,” says Ms Earnshaw. The trust trades at a 31.5 per cent premium to its net asset value.
Profile 2: Hipgnosis
Manager: Merck Mercuriadis
The investment approach: Hipgnosis invests in music catalogues by songwriters — and makes money on residual payments from users.
Key points: Hipgnosis has turned music into an asset class and is poised to cash in on the extension of a song’s life by streaming platforms. It has paid more than £1.3bn since 2018 to song writers in exchange for partial or total rights to components of their streaming catalogues. It operates in some ways like the back office of a record label, profiting from the public’s sustained appetite for content. “Songs are better than gold and oil because if Trump does something stupid tomorrow, gold will be affected, oil will be affected, but music won’t. People are going to always enjoy music,” says Mr Mercuriadis, a slick salesman who came up through the music management industry.
The fund has acquired more than 50,000 songs across catalogues from Barry Manilow, Blondie, Wu-Tang Clan, Motley Cru, and a songwriter for Lady Gaga and RedOne, among others. The fund’s emphasis on songwriters reflects fundamental changes in the industry — fewer performing artists are writing their own songs, relying instead on songwriters. The fund also says it pushes songs back into relevance through placements in movies or getting them covered by younger artists. Record companies invest in artists, in the hopes that they score a few hits. Mr Mercuriadis says: “I’m just buying the hits.”
Profile 3: City of London
Manager: Job Curtis
The investment approach: A fund that invests heavily in established, dividend-paying companies, mostly in the UK, for income.
Key points: One of the UK’s longest running trusts (originally a brewery), City of London is known for its dividend, which it has increased every year since 1966. The portfolio is defensively positioned, Mr Curtis says, increasing holdings in consumer staples this year, while reducing exposure to travel and leisure and other sectors where it will probably take some time for dividends to recover.
The portfolio has largely held on to banks, which it believes remain strong and likely to resume dividends. City of London has fallen behind the main market indices in the past five years as growth stocks have outperformed value companies. But the trust says its collective approach remains a safe bet for income-hungry investors wary of holding individual companies — even top stocks — for dividends. Mr Curtis says: “There’s no such thing as a blue-chip any more.”
Why it might be good for China if foreign investors are wary
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The writer is a finance professor at Peking University and a senior fellow at the Carnegie-Tsinghua Center for Global Policy
The chaos in Chinese stock markets last week was exacerbated by foreign investors selling Chinese shares, leaving Beijing’s regulators scrambling to regain their confidence while they tried to stabilise domestic markets. But if foreign funds become more cautious about investing in Chinese stocks, this may in fact be a good thing for China.
In the past two years, inflows into China have soared by more than $30bn a month. This is partly because of a $10bn-a-month increase in the country’s monthly trade surplus and a $20bn-a-month rise in financial inflows. The trend is expected to continue. Although Beijing has an excess of domestic savings, it has opened up its financial markets in recent years to unfettered foreign inflows. This is mainly to gain international prestige for those markets and to promote global use of the renminbi.
But there is a price for this prestige. As long as it refuses to reimpose capital controls — something that would undermine many years of gradual opening up — Beijing can only adjust to these inflows in three ways. Each brings its own cost that is magnified as foreign inflows increase.
One way is to allow rising foreign demand for the renminbi to push up its value. The problem, of course, is that this would undermine China’s export sector and would encourage further inflows, which would in turn push China’s huge trade surplus into deficit. If this happened, China would have to reduce the total amount of stuff it produces (and so reduce gross domestic product growth).
The second way is for China to intervene to stabilise the renminbi’s value. During the past four years China’s currency intervention has occurred not directly through the People’s Bank of China but indirectly through the state banks. They have accumulated more than $1tn of net foreign assets, mostly in the past two years.
Huge currency intervention, however, is incompatible with domestic monetary control because China must create the renminbi with which it purchases foreign currency. The consequence, as the PBoC has already warned several times this year, would be a too-rapid expansion of domestic credit and the worsening of domestic asset bubbles.
Many readers will recognise that these are simply versions of the central bank trilemma: if China wants open capital markets, it must give up control either of the currency or of the domestic money supply. There is, however, a third way Beijing can react to these inflows, and that is by encouraging Chinese to invest more abroad, so that net inflows are reduced by higher outflows.
And this is exactly what the regulators have been trying to do. Since October of last year they have implemented a series of policies to encourage Chinese to invest more abroad, not just institutional investors and businesses but also households.
But even if these policies were successful (and so far they haven’t been), this would bring its own set of risks. In this case, foreign institutional investors bringing hot money into liquid Chinese securities are balanced by various Chinese entities investing abroad in a variety of assets for a range of purposes.
This would leave China with a classic developing-country problem: a mismatched international balance sheet. This raises the risk that foreign investors in China could suddenly exit at a time when Chinese investors are unwilling — or unable — to repatriate their foreign investments quickly enough. We’ve seen this many times before: a rickety financial system held together by the moral hazard of state support is forced to adjust to a surge in hot-money inflows, but cannot adjust quickly enough when these turn into outflows.
As long as Beijing wants to maintain open capital markets, it can only respond to inflows with some combination of the three: a disruptive appreciation in the currency, a too-rapid rise in domestic money and credit, or a risky international balance sheet. There are no other options.
That is why the current stock market turmoil may be a blessing in disguise. To the extent that it makes foreign investors more cautious about rushing into Chinese securities, it will reduce foreign hot-money inflows and so relieve pressure on the financial authorities to choose among these three bad options.
Until it substantially cleans up and transforms its financial system, in other words, China’s regulators should be more worried by too much foreign buying of its stocks and bonds than by too little.
Square to acquire Afterpay for $29bn as ‘buy now, pay later’ booms
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Payments company Square has reached a deal to acquire Australian “buy now, pay later” provider Afterpay in a $29bn all-stock transaction that would be the largest takeover in Australian history.
Square, whose chief executive Jack Dorsey is also Twitter’s CEO, is offering Afterpay shareholders 0.375 shares of Square stock for every share they own — a 30 per cent premium based on the most recent closing prices for both companies.
Melbourne-based Afterpay allows retailers to offer customers the option of paying for products in four instalments without interest if the payments are made on time.
The deal’s size would exceed the record set by Unibail-Rodamco’s takeover of shopping centre group Westfield at an enterprise value of $24.7bn in 2017.
The transaction, which was announced in a joint statement from the companies on Monday, is expected to be completed in the first quarter of 2022.
Afterpay said its 16m users regard the service as a more responsible way to borrow than using a credit card. Merchants pay Afterpay a fixed fee, plus a percentage of each order.
The deal underscored the huge appetite for buy now, pay later providers, which have boomed during the coronavirus pandemic.
“Square and Afterpay have a shared purpose,” said Dorsey. “We built our business to make the financial system more fair, accessible, and inclusive, and Afterpay has built a trusted brand aligned with those principles.”
Adoption of buy now, pay later services had tripled by early this year compared with pre-pandemic volumes, according to data from Adobe Analytics, and were particularly popular with younger consumers.
Rivalling Afterpay is Sweden’s Klarna, which doubled its valuation in three months to $45.6bn, after receiving investment from SoftBank’s Vision Fund 2 in June. PayPal offers its own service, Pay in 4, while it was reported last month that Apple was looking to partner with Goldman Sachs to offer buy now, pay later facilities to Apple Pay users.
Steven Ng, a portfolio manager at Afterpay investor Ophir Asset Management, said the deal validated the buy, now pay later business model and could be the catalyst for mergers activity in the sector. “Given the tie-up with Square, it could kick off a round of consolidation with other payment providers where buy now, pay later becomes another payment method offered to their customers,” he said.
Over the past two years Afterpay has expanded rapidly in the US and Europe, which now account for more than three-quarters of its 16.3m active customers and a third of merchants on its platform. Afterpay said its services are used by more than 100,000 merchants across the US, Australia, Canada and New Zealand as well as in the UK, France, Italy and Spain, where it is known as Clearpay.
Square intends to offer the facility to its merchants and users of its Cash App, a fast money transfer service popular with small businesses and a competitor to PayPal’s Venmo.
“It’s an expensive purchase, but the buy now, pay later market is growing very rapidly and it makes a lot of sense for Square to have a solid stake in it,” said retail analyst Neil Saunders.
“For some, especially younger generations, buy now, pay later is a favoured form of credit. Afterpay has already had some success with its US expansion, but Square will be able to accelerate that by integrating it into its platforms and payment infrastructure — that’s probably one of the justifications for the relatively toppy price tag of the deal.”
Square handled $42.8bn in payments in the second quarter, with Cash App transactions making up about 10 per cent, according to figures released on Sunday. The company posted a $204m profit on revenues of $4.7bn.
Once the acquisition is completed, Afterpay shareholders will own about 18.5 per cent of Square, the companies said. The deal has been approved by both companies’ boards of directors but will also need to be backed by Afterpay shareholders.
As part of the deal, Square will establish a secondary listing on the Australian Securities Exchange to provide Afterpay shareholders with an option to receive Square shares listed on the New York Stock Exchange or the ASX. Square may elect to pay 1 per cent of the purchase price in cash.
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Biden puts workers ahead of consumers
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For the past 40 years in America, competition policy has revolved around the consumer. This is in part the legacy of legal scholar Robert Bork, whose 1978 book The Antitrust Paradox held that the major goal of antitrust policy should be to promote “business efficiency”, which from the 1980s onwards came to be measured in consumer prices. These were considered the fundamental measure of consumer wellbeing, which was in turn the centre of economic wellbeing.
But things are changing. A White House executive order on competition policy, signed last month, contains some 72 discreet measures designed to stamp out anti-competitive practices across nearly every part of the US economy. But it isn’t about low prices as much as it is about higher wages.
Like the Reagan-Thatcher revolution, which took power from unions and unleashed markets and corporations, Biden’s executive order may well be remembered as a major economic turning point — this time, away from neoliberalism with its focus on consumers, and towards workers as the primary interest group in the US economy.
In some ways, this matters more than the details of particular parts of the order. Many commentators have suggested that these measures, on their own, won’t achieve much. But executive orders aren’t necessarily about the details — they are about the direction of a government. And this one takes us completely away from the Bork era by focusing on the connection between market power and wages, which no president over the past century has acknowledged so explicitly.
“When there are only a few employers in town, workers have less opportunity to bargain for a higher wage,” Biden said in his announcement of the order. It noted that, in more than 75 per cent of US industries, a smaller number of large companies now control more business than they did 20 years ago.
His solutions include everything from cutting burdensome licensing requirements across half the private sector to banning and/or limiting non-compete agreements. Firms in many industries have used such agreements to hinder top employees from working for competitors, as well as to make it tougher for employees to share wage and benefit information with each other — something that Silicon Valley has done in nefarious ways.
This gets to the heart of the American myth that employees and employers stand on an equal footing, a falsehood that is reflected in such Orwellian labour market terms as the “right to work”. In the US this refers not to any sort of workplace equality, but rather to the ability of certain states to prevent unions from representing all workers in a given company.
But beyond the explicitly labour-related measures, the president’s order also gets to the bigger connection between not just monopoly power and prices, but corporate concentration and the labour share.
As economist Jan Eeckhout lays out in his new book The Profit Paradox, rapid technological change since the 1980s has improved business efficiency and dramatically increased corporate profitability. But it has also led to an increase in market power that is detrimental for people in work.
As his research shows, firms in the 1980s made average profits that were a tenth of payroll costs. By the mid 2000s that ratio had jumped to 30 per cent and it went as high as 43 per cent in 2012. Meanwhile, “mark-ups” in profit margins due to market power have also risen dramatically (though it can be difficult to see this in parts of the digital economy that run not on dollars but on barter transactions of personal data).
While technology can ultimately lower prices and thus benefit everyone, this “only works well if markets are competitive. That is the profit paradox,” says Eeckhout. He argues that when firms have market power, they can keep out competitors that might offer better products and services. They can also pay workers less than they can afford to, since there are fewer and fewer employers doing the hiring.
The latter issue is called monopsony power, and it is something that the White House is paying particularly close attention to.
“What’s happening to workers with the rise in [corporate] concentration, and what that means in an era without as much union power, is something that I think we need to hear more about,” says Heather Boushey, a member of the president’s Council of Economic Advisors, who spoke to the Financial Times recently about how the White House sees the country’s economic challenges.
The key challenge, according to the Biden administration, is that of shifting the balance of power between capital and labour. This accounts for the emerging ideas on how to tackle competition policy. There are many who regard the move away from consumer interests as the focus of antitrust policy as dangerously socialist — a reflection of the Marxian contention that demand shortages are inevitable when the power of labour falls.
But one might equally look at the approach as a return to the origins of modern capitalism. As Adam Smith observed two centuries ago, “Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all wealth of the world was originally purchased.” Reprioritising it is a good thing.
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