How investment trust boards work

As with all publicly listed entities, the board plays a key role in providing governance and oversight to ensure shareholders’ interests are protected and the trust is managed in line with its stated mandate to deliver on investor expectations. 

Boards are central to smooth running of an investment company, even if they are not involved in the day-to-day management of its underlying portfolio.

Given the importance of its role, a board’s composition and the competence of its members now comes under much greater scrutiny, and the historical criticism that investment trust boards were little more than old boys’ clubs no longer applies.

A solid assessment of an investments trust’s non-executive directorships should form a central consideration for those analysing investment trusts and their suitability for investors. 

To accomplish this, it is important to establish what a board’s core duties are and how well matched the directors are in fulfilling those duties.

Boards usually meet on average four to five times a year to discuss all activities that ensure the smooth running of an investment trust. 

These discussions naturally include a review of the performance of a trust’s manager or managers but may also involve sales and marketing plans, appointing or removing suppliers and monitoring a trust’s audit committee, whose role it is to keep financial matters in check. 

This committee usually meets twice a year to review the accounts and sign off the interim and full-year accounts. There may also be a separate remuneration committee.  

Controlling the discount

In addition to ensuring shareholders' expectations are met from an investment perspective, one crucial role the board plays is controlling the discount or premium at which a trust’s shares trade. 

An investment trust’s share price may vary from its net asset value depending on market demand and sentiment towards it. If its share price is above its net asset value, a trust is said to be trading at a premium; if it is lower, the trust trades at a discount. 

This distinctive element of the investment trust structure has come under close attention of late as weak investor sentiment has led to swaths of them trading at wide discounts. However, investment trust boards can take steps to address this by implementing a discount control mechanism. 

The most commonly used is buying back up to 14.99 per cent of a trust’s share issuance to rein in a discount. Conversely, in times of strong demand, they may issue new shares in a tender offer.

Boards also set other policies that can affect a trust’s performance, such as gearing, by which they can use debt instruments that can amplify gains (or losses). 

An investment trust can retain up to 15 per cent of its earnings, which can then be paid out in future years, and can ask the shareholders for authority to distribute from capital reserves as income, which can smooth income distribution. 

This can be beneficial to investors as it offers a clearer idea of dividend expectations. This is a particular advantage to those in retirement who need greater certainty over the levels of income they might receive from their investments.

Boards will also oversee an investment trust’s sales and marketing activities to help stimulate investor demand and ensure liquidity, reducing levels of risk. 

The additional layers of due diligence and accountability, coupled with a fiduciary duty to act in the best interests of shareholders, mean boards are central to smooth running of an investment company, even if they are not involved in the day-to-day management of its underlying portfolio.

Assessing the composition

It is therefore important to evaluate a board's efficacy, with certain elements being core to this analysis. These include its composition, its independence, the skill set and background of its non-executive directors and how they complement each other. 

An important consideration is how well aligned board’s interests are with shareholders.

One effective way of measuring the board’s alignment of interests is gauging the extent to which its members have skin in the game.

All non-executive directors receive remuneration from the trusts on whose boards they sit and investors should expect a director’s personal investment in a trust to be commensurate with the annual salary they draw from it. 

There may be instances where this is problematic. 

For instance, it can be advantageous for boards to count younger members within their number who might not have accrued sufficient personal wealth for this to be possible. 

Nonetheless, non-executive directors should be personally motivated to ensure investor returns are as strong as possible, and a meaningful investment in a trust provides a good measure of this.   

Diversity is also very important, and this is an area where the investment trust sector has seen considerable improvement over recent years. 

The representation of women on investment trust boards has, for instance, increased significantly, and women now account for more than 40 per cent of investment trust directorships.

As well as gender diversity, it is important that a board contains qualified people from a range of backgrounds as this brings fresh perspectives on ways in which its performance can be optimised.

Alongside the need for diversification there are other important considerations in assessing a board’s composition. 

It should contain someone with accounting skills to monitor the financial elements of a trust’s management, as well as someone with a background in investment markets who can hold the trust’s manager to account.

Should the trust have a niche mandate, such as property or Asian equities, it is clearly helpful to have experience in that sector or region.

It can be advantageous to see a marketeer on a board, or one who has a background in fund distribution, to promote an investment trust to new shareholders, given an increasingly competitive marketplace. 

As well as the composition of the board, it is important to monitor the tenure of its members.

Shareholders should raise questions if any non-executive directors have been in place for more than nine years.

In addition, they should watch for "over-boarding" where individuals are spread too thinly over too many directorships across different companies.

While investment trust analysts and other fund professionals undoubtedly have privileged access to boards, shareholders also have the opportunity to hold investment trust boards to account.

As publicly listed entities they are obliged to hold an annual meeting, which all shareholders are free to attend. 

This provides a forum for them to raise specific concerns directly with the board, scrutinise its performance and vote on issues such as the appointment or reappointment of non-executive directors, their remuneration and the continuance of the trust’s manager.  

This channel of engagement is not open to investors in other types of investment vehicles and creates a platform to address any irregularities a shareholder might have recognised in a trust’s management. 

A good board will consider these recommendations and take action where appropriate, making this a very powerful force for potential change. 

Jock Glover is strategic relationships director at Square Mile Investment Consulting and Research