A British lawyer created the first investment trust in 1868 to pool small amounts of money and buy bonds from nations ranging from Turkey to Egypt.
The closed-end funds that were traded on stock markets are now worth approximately £260 billion (318 billion). The sector grew in the record low interest rate era, and its size more than doubled. Its pitch was simple: high returns for the masses.
Now, interest rates at central banks and bond yields have reached multi-year highs. This has destroyed markets all over the world. Closed-end fund have not escaped destruction, and their allure is rapidly declining.
Investors can make money in a safer and easier way with gilts that yield more than 5%. According to Morningstar and the Association of Investment Companies, the average UK trust trades at a discount of 17% to its asset value. This is the highest since the financial crisis of 2008.
This has sparked the largest shakeup of the industry in over a decade. Fundraising is down and many funds are merging or closing to gain scale. The FTSE All-Share Closed End Investments Index has fallen about 6.5% in 2024 compared to the broader market.
Hipgnosis Songs Fund is one of the most high-profile victims, as it faces liquidation if royalties from artists like Red Hot Chili Peppers or 50 Cent are not enough to offset the soaring rates.
Matt Hose, analyst at Jefferies, said: “The most obvious structural threat at this time is that the entire sector is at a discount, and no one is able to raise equity.” There will be a lot of creative destruction.
Trusts, also known as investment companies in the UK, raise money by issuing shares. However they do not have to redeem them. They can take a long-term approach and invest in private assets such as solar farms, student dormitories and music royalties.
Trusts were a bright spot for London until recently. Other sectors had been fading due to a series of acquisitions and a slump in the number of new listings. More than 80 of the FTSE 350 Index are trusts compared to 44 a decade earlier.
Now that trend has reversed. The amount of money raised this year has been reduced to £1.1 billion, the lowest since AIC’s data dating back to 2006. Funds are closing down, and this is adding to the exodus from London’s Stock Exchange.
Not all trusts are designed to generate income for their investors. The universe of almost 370 companies includes those that are looking for capital growth, investing in everything from British Small-Caps to Uranium Miners and Vietnamese Shares.
In a world of low yields, trusts were a popular way to invest money. They offered a steady dividend payment as the main attraction. British trusts have the ability to retain income in order to maintain payouts during good and bad years.
Only eight of the 22 trusts that the AIC has classified as renewable energy infrastructure have a track record longer than five years. According to the AIC the average dividend paying company yields now 4.37%, which is about one percentage point less than the rate of three-month UK Treasury Bills.
Iain Scouller is an analyst with Stifel. He said: “Many of these structures weren’t available 10 or 15 year ago. This is the first time they have been tested under a rising-interest rate environment.” It’s going be difficult for discounts until we start seeing some of the gilt yields go down.
The Bank of England will keep its benchmark rate high for a while, as UK inflation is still slowly declining.
About 17 trusts have left the market this year or are on their way to leaving the market. AIC data shows that another 10 trusts have announced their plans to return money, which is a common precursor to closing down.
Hipgnosis’ music catalog, which includes Blondie, Neil Young and others, suspended the payment of its dividend to avoid it breaking covenants. A similar trust, the Round Hill Music Royalty Fund was sold earlier this year at a discounted price to its net asset values. After a director criticised the management of Scottish Mortgage Investment Trust, its board was reshuffled.
Hose, Jefferies, says that trusts that have a large portfolio of unlisted assets are seeing steep discounts. This is due to the poor demand for these assets and the fear that their value will be lower than what they currently estimate.
Morningstar Direct data shows that private equity and property trusts both trade at 38% below the estimated fair value.
Arbitrageurs, on the other hand, are looking for bargains at the reduced prices. Data compiled by Bloomberg shows that Boaz Weinstein, whose Saba Capital Management is known for pushing for changes in closed-end funds, has built up a stake of nearly 6% in the European Opportunities Trust.
The existential crisis that is tearing apart UK trusts goes beyond the BOE’s hawkishness.
The rule that requires money managers to disclose the costs they incur when investing in trusts has increased selling pressure. Sector has said that this is misleading, as their expenses are already included in their share prices. A bill was submitted to the House of Lords for these companies to be exempted from the requirement.
The structure is still a stronghold against the global money management tides, which has seen massive flows of money into passive, cheaper products managed by financial giants.
According to Nick Wood of money manager Quilter, the open-ended funds can be cheaper than trusts. The mergers of wealth managers have also led to a greater appetite for large funds. This has in turn led to more trusts being combined.
Wood stated that consolidation is not helpful to the industry of investment trusts when the buyers are doing it.