The big problem with UK investment trusts
UK investment trusts are one of the most important parts of our capital markets, but the sector is grappling with a valuation problem that can no longer be dismissed, writes Ben Green
The UK investment trust sector is one of the most important, and often misunderstood, pillars of our domestic capital markets. More than 300 investment trusts are listed in London, spanning equities, private equity, credit, infrastructure, renewables, property and specialist real assets. Collectively, the sector represents well over £250bn of assets and provides permanent capital to areas that are otherwise difficult for public market investors to access.
Yet despite this scale and relevance, the sector is grappling with a valuation problem that can no longer be dismissed as cyclical. Share price discounts to net asset value (NAV) have become persistent across wide swathes of the market, particularly in alternative and real asset strategies. In many cases, the market is no longer waiting for performance to improve. It is questioning whether the investment trust structure itself delivers fair outcomes for shareholders. At the centre of that reassessment sits a combination of entrenched management and fee structures that appear misaligned with shareholder interests.
External management has always been a defining feature of the UK investment trust model. It offers flexibility, specialist expertise and scalability. But it has also historically raised concerns about potential misalignment between managers and shareholders. Where the original strategy and fee structure become detached from shareholder outcomes, the closed-ended structure risks magnifying value leakage rather than containing it.
In a traditional, internally managed company, when strategy fails – for example following a poorly conceived acquisition – the chair takes responsibility for replacing the executive management, usually the CEO and CFO. This provides an opportunity for a genuine strategic reset. By contrast, meaningful change of manager happens surprisingly infrequently in externally managed investment trusts. Founders of the management company tend to be entrenched, and boards have often been reluctant to confront underperformance directly.
How investment trusts can reform fees
There is a straightforward solution that addresses both strategy and fees. Boards of investment trusts should run a genuine re-tender of the investment management contract on a periodic basis. In many cases, this may result in the reappointment of the existing manager. However, it would provide a true market test of fee levels and, importantly, could surface alternative strategies better aligned with maximising shareholder value.
Turning to fees, the most common arrangement remains the NAV-based management fee, under which the manager is paid a fixed percentage of net assets, usually calculated and accrued quarterly. For mainstream investment trusts, base fees have historically clustered around 0.75 per cent to 1.0 per cent of NAV. Many trusts operate tiered fee schedules, with marginal rates stepping down as assets exceed defined thresholds.
In a market where discounts were narrow and temporary, this model was broadly defensible. In a market where discounts of 20 per cent to 40 per cent can persist for years, it has become increasingly problematic. Shareholders continue to pay fees on NAV while the market values the equity materially lower. The manager’s revenue is largely insulated from that reality, while shareholders bear both the discount and the opportunity cost.
The issue can be compounded when fees are layered throughout the structure. In addition to the base management fee, some trusts compensate managers for development management, operational oversight, third-party contract management, transaction execution and financing-related services. While some of these costs may be legitimate, they can create additional conflicts of interest and further entrench underperforming managers.
The rise in shareholder activism across the investment trust sector is therefore unsurprising. Persistent discounts, combined with entrenched strategies and fee structures that appear insulated from outcomes, create an obvious pressure point. Where boards do not act to rectify misalignment, others will seek to force the issue.
Encouragingly, the sector is beginning to adapt, although comprehensive reviews of management arrangements remain relatively rare. Several investment trusts have reduced base fees, introduced blended fee bases, often with equal weighting between net asset value and market capitalisation, simplified layered arrangements and improved disclosure. These changes do not eliminate discounts overnight, but they address a central objection investors have to the structure.
More, however, remains to be done. While shareholders will always value a high-quality management team, recent years have demonstrated that traditional external management agreements do not necessarily place shareholder value at their core. Beyond a fee structure that genuinely aligns interests, additional mechanisms are required to ensure that an investment trust does not become, in practice, captive to its manager. Systematic re-tendering of management contracts every two to three years should be regarded as a minimum governance standard.
In this context, investment trust boards are on the frontline. Those that recognise this new paradigm and act decisively will be best placed to restore confidence in a sector that still has much to offer. Those that do not are likely to face continued activism and increasing difficulty in justifying the status quo.
Ben Green is co-founder of Atrato Group