Ian Sayers, Chief Executive
Welcome to this edition of ‘Beacon’, which features articles on ‘overboarding’ and the changing shareholder profile of investment companies. We also take a look at a new service launched by the AIC for investors looking to build an income portfolio.
Please click on the ‘Contents’ tab at the top of the page to see chapter headings so that you can dip in and out according to what interests you most.
2019 has seen the investment company sector’s assets hit new highs, exceeding £190bn for the first time at the end of April 2019.
Fund raising is also significantly up on the same period in 2018, with some £2.8bn having been raised in 2019 to date. Most of this has been from existing funds raising new money, as the conditions for IPOs remain challenging.
March also saw the AIC UK Conference 2019 ‘Preparing for the next generation’. The programme this year was firmly focused on the future considering some of the big drivers of change that will shape demand for investment companies in the years ahead. Over 400 non-exec directors and senior professionals from the sector came together for the conference and BBC’s Huw Edwards expertly moderated the day, bringing a blend of both humour and seriousness to the key issues.
Expert speakers covered areas such as the potential impact of disruptive technologies in financial services, how economies and markets may react in a world of profound political change both at home and abroad, the rise of alternatives, and where demand for investment companies may come from in the future. If you weren’t able to attend the conference in person, you can download the presentations and other conference materials here.
We hope you find the articles in this edition interesting and informative. As ever, please do let know if there are any issues you would like covered in future editions.
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Taking it all on board
Guy Rainbird discusses the challenging issue of 'overboarding'
Guy Rainbird, Public Affairs Director
‘Comply or explain’ governance promises flexibility and high standards. These laudable objectives often flounder when reality bites. It is a huge challenge to design broadly-applicable, practical systems able to take account of the different circumstances of companies and their boards. Because of this, investors often follow general policies which are less flexible than many would hope. A case in point is the question of whether an individual director has enough time to devote to their role or whether they are ‘overboarded’.
Best practice says directors should have “sufficient time to meet their board responsibilities”. How this principle should be interpreted is, for the most part, left open. The Financial Reporting Council, which sets standards in this area, offers guidance only to the extent that “full-time executive directors should not take on more than one non-executive directorship in a FTSE 100 company or other significant appointment.” Otherwise, that’s it.
At one level this is sensible. This question is a matter of judgement and depends on specific circumstances. It is nonetheless a challenge for investors to understand, and take a view on, the position of, potentially, thousands of individual directors on hundreds of boards.
One approach is to apply a numerical formula to board appointments. While variations on this theme exist, perhaps the best-known approach is that of Institutional Shareholder Services (ISS). Its policy includes a scoring system specifying that individuals should not have positions which accrue, in total, more than five ‘mandates’. Each listed company directorship is counted as one mandate. The role of ‘chair’ is counted as two mandates.
This approach is clearly convenient but, at first sight, also has significant drawbacks. Its focus arguably penalises those with a portfolio of listed company directorships while not taking so strict a view of those with other private or charitable interests. There is no obvious differentiation between the time taken to discharge a role on a complex trading company (perhaps one with multinational interests, complex organisational structures and significant operational risks) compared with the potentially less onerous requirements of an investment company with a more narrowly focussed oversight agenda.
Fortunately, the risks of these formulaic approaches can be mitigated. Feedback from various agencies and investors with ‘points-based’ systems is that these limits are not as inflexible as they may seem.
There is recognition that investment company directorships can be less time-intensive than other listed company roles. Where adequate information is provided some agencies and investors can be persuaded that breaching their policy’s points limit need not always disqualify a director from taking up an additional position. The key to achieving a sympathetic hearing is setting out in the annual report an explanation of the commitments of the individual and why the board considers that they have the capacity to undertake the role. This explanation should go further than stating that the board believes an individual has enough capacity. Where more information has been provided, directors with non-executive investment company portfolios have reported being able to secure additional positions without attracting negative recommendations and votes. This is a challenging issue, but evolving practice indicates that greater transparency, potentially alongside engagement, can overcome some of the downside of governance formulae. Certainly, not providing clear explanations raises the risk that the numbers alone will govern investor views and votes.
Listed board positions of investment company directors. Source - BoardEx
Public Affairs Director
T: 020 7282 5553
David Michael shines a light on the AIC's new tool for income-focussed investors
David Michael, Website and Statistics Director
"When I talk to our shareholders and ask what they do with their dividend, they say it goes out of their bank account and pays their gas bill."
Bruce Stout – Murray International
Investors looking to invest in investment companies to provide a regular income to help meet living expenses may be able to rationalise capital movements as ‘paper’ gains and losses. But, as Bruce Stout from Murray International noted, dividends are all too real.
The abolition of any requirement to purchase an annuity, coupled with continued low interest rates, have played to investment companies’ strengths. And there are no shortage of analysts willing to suggest individual investment companies, or indeed portfolios, that will generate a high level of annual income or an income that will grow over time. But is that enough?
The total level of income in a year is important, of course, but so, in the real world, is its timing. We all have regular monthly bills to pay and times of the year, like Christmas, when we wouldn’t mind a bit more coming in. It was this thought that led the AIC to develop its Income Builder. A tool which allows investors to create portfolios of investment companies and see exactly how much income they generate and, just as importantly, when this income would be paid. To access Income Finder's tools and resources, investors will need to create their own account, acknowledging associated risk warnings.
To demonstrate how Income Finder can help, we constructed a portfolio based on one analyst’s recommendation of 10 investment companies which it believes will provide a balanced, growing income over time. We constructed the portfolio based on investing £10,000 in each company.
Figure 1: Original income portfolio
As Figure 1 shows, the annual level of income is a healthy 3.8%. But the disparity in the levels of income each month is striking. Nearly £800 in October, but nothing in March, September and December. Looking at November as well, Christmas is going to need some careful budgeting.
If this income profile doesn’t appeal, then the Income Builder can help, as it can filter investment companies by what month they pay dividends in and how frequently. So, in the case of the above portfolio, we removed three investment companies from the ‘bumper’ months and replaced them with three investment companies from the same sectors but with different dividend payment dates.
Figure 2: Amended income portfolio
As Figure 2 shows, this not only resulted in a slightly higher income but one that is much more evenly distributed over the year. No less than £300, or more than £430, in any single month.
The Income Builder is the centrepiece of a new section of the AIC website, the AIC Income Finder. In addition to the portfolio tool, this section allows investors to track individual dividend payments via the Dividend Diary, as well as accessing a Guides and Glossary section explaining all about the benefits and risks of using investment companies to generate an income. As ever, investors can click through from an individual company name to the profile pages to research their choices in more detail.
Users of the AIC website have always had the ability to create and monitor portfolios of investment companies via our Watchlist service. Income Finder adds a new dimension to the site by responding to the needs of investors.
Although it’s early days, more than 1,500 investors have now set up a portfolio on Income Builder since its launch in April, boosting visits to the site to record highs as well as attracting positive national and trade press coverage.
Website and Statistics Director
T: 020 7282 556
Richard Davies, Managing Director at RD:IR, discusses the rise of investment company purchases via platforms
Richard Davies, Managing Director at RD:IR
If there is one thing that has characterised the change in buying patterns in the investment company sector this decade, it has been the rise of platforms as the way of purchase by retail investors. As a company that regularly analyses the ownership of over 200 investment companies, accounting for around 70% of the AIC membership by market capitalisation, we are in a prime position to detect trends in both who owns UK closed-end funds, and via which routes those investments are made. Our research, carried out over many years, shows that the proportion of investment company equity held via Direct to Consumer (“D2C”) platforms has doubled since the introduction of Retail Distribution Review (RDR).
"If there is one thing that has characterised the change in buying patterns in the investment company sector this decade, it has been the rise of platforms as the mode of purchase by retail investors."
Richard Davies, Managing Director at RD:IR
The increasing importance of platforms for retail investors will be of little surprise to any investment company board or investment manager. Indeed, it may well be a source of frustration in terms of the perceived disintermediation of issuer and investor, especially in terms of voting, and a considerable challenge in terms of marketing. Life in the digital age is more complex than hitherto in many ways.
What may be surprising, however, is that while the overall proportion of the investment company sector held by retail investors in terms of market capitalisation has stayed just about the same at 70% since RDR, the 9% rise in platform ownership has been outstripped by the 12% decline of retail investors holding in their own name on the share register. Our analysis of investment company share registers shows us that many retail investors have simply re-registered their shareholdings to the custodians used by the platforms or the wealth managers and private banks.
What is more difficult to discern is whether there is any new advisory situation in place for these investors or whether these changes represent merely a technical change of registration due to the costs attached to retaining a CREST membership. We know that historically many retail investors used advisory firms even when their shares were registered in their own name.
We also recognise that a proportion of shareholders registered in nominee accounts which are linked to non-discretionary entities have always been either discretionary or adviser managed by third parties. However, these identification issues are small, relative to the overall market trend.
Our analysis shows that there has been a significant increase in the value held by private client brokers, wealth managers and private banks, which grew by 5% in aggregate. We assume that part of the decline in self-registered retail shareholders is to the benefit of the non-discretionary portion of the wealth managers’ holdings.
Of course, the market has not been static since RDR arrived. The AIC sector has more than doubled in value, from £75 billion at end 2012 to £178 billion at end 2018, reflecting both the arrival of new companies and the many new issues of shares for existing companies, as well as the growth of underlying assets. The alternative investment company market now accounts for around 40% of investment company market capitalisation, up from 35% at end 2012.
"...the market has not been static since RDR arrived. The AIC sector has more than doubled in value, from £75 billion at end 2012 to £178 billion at end 2018..."
Richard Davies, Managing Director at RD:IR
Non-retail ownership of investment companies on a proportional basis has remained static since RDR, partially supported by the take-up of shares in alternative investment companies by institutional investors, which have largely eschewed traditional investment companies since the noughties. Our research shows alternatives also display “institutional ownership decay” over time to the benefit of the retail investor (the average ownership is roughly half institutional, half retail).
From a marketing perspective, we need to understand better the drivers for investment company share purchases, and what is being bought on a self-directed, advisory or discretionary basis. The numbers would suggest that the greatest rise in investment style in this sense is self-directed, with execution being enacted via the retail platforms. The numbers would also suggest that the rise of platforms do not represent sizeable numbers of new investors but instead often the previous investors moving their shares around the share register but if we are to market the investment company world to new investors, then the data begs the question of how best to do this.
Given the importance of platforms in the digital age in regard to investment company purchase, the platform lists have become key influencers of investment decision-making. One could argue that self-direction is a less than meaningful term when investment choices are being influenced so heavily by the construction of these lists.
Investment company marketing requires appropriate and relevant data in terms of ownership and buying patterns. Our understanding of the relationship between beneficial owners, custodians, platforms, advisers and fund managers is governed by the constraints of what is discernible from the share register and the information we can garner from shareholders on behalf of our investment company clients by strategic use of their powers under Companies Act Section 793. There are other sources of data on buying patterns, but these are often partial or misleading. The industry would benefit from greater transparency between share registration structures and related market players but without the incentive of payment or legal imperative to invoke change, it is difficult to imagine how things will improve in the short-term.
We are mindful that the investment company industry is evolving in both the structure of ownership and investor route to purchase. We are looking this year to update our taxonomy of investor types, investment styles and market routes in our reporting for our investment company clients. We will first canvass opinion across the AIC membership to achieve the most popular categorisation taxonomy. While we may not be able to please everybody in the sector, I am sure we can find a working model that will provide useful insights to help boards and managers navigate the increasingly complex waters.
Managing Director, RD:IR
T: 020 7492 0501