Enhancing Investment Trust Performance by Minimising Costs

by Richard Class

Close up of glazing on The Gherkin at 30 St. Mary's Axe, in the City of London. Home of the Investment Trust.

How Investment Trust boards can boost performance by minimising costs

Investment Trusts face a challenging environment. AUM growth has stalled over the last few years with very limited fundraising and new issues. Widening discounts to NAV have increased pressure on boards, with a rise in mergers and consolidations. Recent rapid inflation has increased fixed costs, with no compensatory rise in income. Add to that the controversy over cost disclosures and whether they discriminate against the sector, and many boards are left wondering what role they can play to instigate a turnaround in their fortunes.

Identifying explicit and implicit costs

Most investment companies outsource all their day-to-day activities. Key elements of the board’s role are to ensure the service providers are delivering what they are contracted to provide and that the company is receiving good value for money for shareholders.

When analysing the costs borne by the investment company, directors are familiar with the explicit costs paid. These include registration and listing fees, directors’ fees, audit fees, legal fees, AIFM fees, broker fees, and administration fees.

However, directors may be less familiar with implicit costs that the company bears, i.e. where the company does not directly ‘write a cheque’ for goods or services and there is no information on these costs in the report and accounts. Implicit costs could include:

  • Trading costs in buying and selling the assets the investment trust owns.
  • Trading costs in hedging the portfolio. Instruments traded include spot and forward foreign exchange, and derivatives on the underlying asset class the trust owns (e.g. equities, interest rate, credit).
  • The costs of gearing (if used).
  • The interest rate earned on uninvested cash.

Out of sight, out of mind

The investment manager will usually pay close attention to the first item on this list. Having carefully selected the optimal assets for the portfolio, managers want to ensure best execution. However, the rest of the items on this list are ancillary to the underlying investments and although necessary, may be considered to be less important. Nevertheless, sub-optimal execution can be a material drag on fund performance.

In non-fixed income funds, it is possible that the managers are less familiar with the nuances of the FX and funding markets. For ease of execution (and possibly to avoid the placing of collateral) these “ancillary” items may be executed with a single counterparty who could take advantage of this monopoly position.  As a result, funds may be “overpaying” for these items, but as these costs are implicit, they are much harder to identify and therefore tend to receive little scrutiny.

Seeing the wood through the trees

The impact of reducing implicit costs can be substantial, particularly in relation to the magnitude of explicit costs and the efforts taken to control them. For example, suppose an investment trust with AUM of £200m has audit fees of £100,000 and trades £1.2bn GBPUSD FX volume per annum. A mere 1bp improvement in FX pricing would save the fund USD120,000 (almost the entire audit fee) annually. In practice, potential savings may amount to multiple bps per annum. These savings are passed directly to shareholders in improved performance, and they compound further over time.

Leave no stone unturned

OptimX provides board directors in the investment management sector with a degree of due diligence that implicit costs are kept under close control. We have Investment Trust NED experience, which means we see things from the directors’ perspective.

OptimX is independent and does not seek to impose solutions. Rather, we work with existing service providers and use our experience to monitor diligently. Where necessary, we can sensitively negotiate better terms for the fund. The outcome delivers comfort to the board directors and investors, allowing them to rest assured that no stone has been left unturned.  Boards rightly focus on controlling OCF, OptimX partners with boards to minimise implicit costs.

Richard Class is a Senior Advisor to OptimX and is a Non-Executive Director of TwentyFour Select Monthly Income Fund Limited.