FCA 'Shouldn't Throw Baby Out With Bath Water' Over Listing Reforms

WATCH: Witan Investment Trust's Andrew Bell argues policy makers are right to look at UK listing rules, but certain standards should be preserved

Ollie Smith 23 January, 2024 | 9:00AM
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Ollie Smith: Welcome to Morningstar. If you were paying close attention to investment trusts last year, you might be very keen to find out what's going on with them in 2024. So, I'm pleased to say kicking off our coverage for this year is a special guest in the studio with me today. It's Andrew Bell, Chief Executive of the Witan Investment Trust.

Andrew, thanks for your time today. Talk to me first about performance in 2023. What were the particular contributors or detractors to performance?

Andrew Bell: Well, a year ago, the whole world was in a big funk about how we were certain to have a recession because of rising interest rates and so forth. There was a lot of gloom and markets were quite cheap and contrary-wise we actually put on quite a lot of gearing at the end of 2022. So, one of the drivers for our performance last year was that we were geared throughout the year and in a year of rising markets that helped returns.

The two headwinds that we had were first of all the massive concentration of performance within the US market particularly where I think about 60% of the rise in the market was driven by the Magnificent Seven tech stocks. Brilliant if you were a tech manager. More difficult if you have a more diversified portfolio. And the other side was the widening of discounts within the investment trust sector because we do invest about 10% or 15% of Witan's assets in investment trusts in specialist categories. And clearly, in a year when discounts were widening and there was very little demand for investment trusts generally, negative investor sentiment, that held us back. So, we generated – I mean our results are due out in March but most of it's already in published information. Our total return was just under 13% in NAV total return terms, slightly behind the benchmark but well ahead of inflation.

OS: And the trust is 2-Star rated by Morningstar. What in your mind is the key benefit of running a multi-manager approach?

AB: I think you've got three things really. One is you've got diversification by manager. So, if one manager is having (a mare) of a year, the whole portfolio isn't going to be sunk below the water line. The second is it's easier to steer the portfolio. It's a big effort. If an investment trust board loses confidence in its manager, there's a big hurdle to decide to change the manager of 100% of the portfolio. Much easier to change the portfolio, 10% or 15% of the portfolio. So, if you've either lost confidence in a particular manager or found a better idea, it's easier to change and adapt as you go along. And the other side is horses for courses. Not every global manager is going to be as good in Japan as they are at European smaller companies. So, you can appoint specialists to do what they're best at.

OS: Okay. And in terms of the UK, I think you alluded perhaps to the contrast between UK equity investing and U.S. equity investing and the Magnificent Seven. But one of the holdings in the trust is RELX [RELX]. What are the other opportunities that you see in the U.K. specifically at the moment?

AB: Well, the U.K. is – I mean, RELX is an interesting one. I'm not at all an expert of it, but I know one of our managers is Lindsell Train and in their recent fact sheet they alluded to the fact that I think RELX is the strongest performing of the original FTSE 100 stocks from 40 years ago. And £100 are turned into £35,000 or something, wonderful. And so, they hold it in the international portfolio they manage for us.

I think the thing that's become a bit of a standout over the last 12 months or so is the degree to which policymakers and regulators are beginning to fret over the fact that the U.K. stock market has become so cheap. It's not just an investment issue. I think people have recognized that stock market is there to raise growth capital for companies. And if the market is really not very receptive so that the good companies go somewhere else, and the other companies can't raise money because pension funds and insurance companies have spent the last 20 or 30 years reducing exposure to U.K. equities, that is a policy problem. And so, a market which has become – it's become cheap relative to international comparators even if you accept that it's a different sector mix. And it's become under-owned by domestic institutions for the regulatory reasons I alluded to and under-owned by internationals because they felt that right or wrong. They felt that Brexit was an own goal from the U.K.'s point of view. So why bother allocating to such a small market?

So, it's if it's under-owned by domestic and foreign investors become relatively poorly valued. Nobody quite knows what the catalyst is, but it does look like a source of very cheap stocks. And it's one of those things once it starts moving, it could actually end up being chased because people suddenly realize they've overlooked this pool of bargains and particularly the small domestic stocks. Now I'm not particularly recommending those. but it is a fact that the domestic stocks are lowly rated compared to the UK market which is lowly rated compared to international competitors. When will it change? Who knows?

Smith: Sure. And this, as you said, became a policy problem. And we heard plenty of announcements, not just about equities and markets last year, but also about other areas of UK finance, all with a kind of UK growth, growth, growth bent, shall we say. And Jeremy Hunt has made no secret of his desire to really get things moving, so to speak, in the city. One of the things that regulators and central government are working on is a listings regime change, essentially. What was your reaction to that? And do you feel confident that it's now heading in the right direction?

AB: I think you've got to be careful not to throw the baby out with the bathwater, because one of the reasons a lot of foreign companies wanted to list in the UK was because it had a respected set of requirements in order to be listed. And there was a quality threshold. And so, if you abolished the quite quality threshold, the danger is you're going to end up with lots of poor-quality companies coming along, or the market gets poorly rated because people think, well, I don't trust the accounts. I don't think that is happening. But some of the – I think the default seems to have moved from instead of having a set of rules that you must comply with, say, well, you don't have to comply with these, but you do have to explain. So, it's more of a caveat emptor thing, which probably doesn't matter if you're a 50-year-old building company or an oil company or whatever, or a food company, something with an established business. It probably does matter if you're a rapidly growing small startup in the technology space where you probably don't have the trading record to be able to meet all the old prospectus requirements. So, I think that is a benefit. But it's a slow burn. It's not going to dramatically turn around the fortunes of the UK market on its own. That will come because of cheapness or a change in willingness to buy the UK But over 10 years, diverting the things like Mansion House Reforms, the Edinburgh reforms, making the regulations less onerous, helping to divert more money towards startups and growth companies, that should help the rating of the market because it's taking 25 years to ruin it.

OS: Okay. Definitely put. Just to pick you up on what you said about caveat emptor, I mean, it's very interesting that you look at it from the perspective of perhaps older companies and younger companies. How do you feel about the idea of, shall we say, older investors and younger investors – I mean, people who spent less time investing, perhaps encountering a new regime, perhaps places them in a slightly riskier situation might be fair to say? What's your sense as regards investors themselves?

AB: Well, I think don't invest beyond your confidence or competence is one thing, which the whole origin of investment trusts and unit trusts and OEICs has been to give people of limited means or limited time a way of diversifying their portfolio so that they don't put it all on red rum as it were, or Shergar, which then gets kidnapped and…

OS: The metaphor.

AB: Exactly, enough of the horses. So, I think, it's for the FCA to, in loosening some of its requirements, to make sure either that the marketing to retail investors who are perhaps less able to do the due diligence is appropriately regulated itself or to ensure that the intermediaries who manage portfolios for individuals are aware of the benefits of diversification. But it's not a one-off shot. If you find that you've – there will always be scallywags and miscreants and mistakes, whether predictable or not in any market.

One of the things you need to do is to try and protect people against being caught out by those things. But equally, you can't protect people against all of those risks. Because one of the theories about why pension funds were regulated to invest for risk control rather than for return, where it goes back to the time when Robert Maxwell robbed the pension fund of his employees. And the feeling was you needed to find a way of making sure that there were enough assets in the fund to guarantee in all circumstances that the liabilities could be met. And I think that led to an over focus on risk. Whereas my view is it's important to identify where you can make returns and then have an appropriate risk control mechanism on top of it. If you start with minimizing risk, then actually, oddly enough, there's nowhere where you can make any returns as the pension funds found a year ago when they found that they were overexposed to bonds when they fell out of bed.

OS: Okay. I started with investment trust. So, I'll end with investment trust. Just finally, lots of people at the end of last year were saying that investment trusts are going to be one of the real talking points for good or for ill in 2024. What's your sense on that? What's your feeling about investment trusts as a vehicle, in terms of popularity, in terms of flows, inflows, outflows in 2024?

AB: I don't know when the flows will change. I mean, there has been a structural outflow partly because in the wealth management sector, some investment trusts do what the wealth managers do themselves, so they have less need to buy an investment trust. And in some cases, because of regulation, they've had to give an unrealistic assessment of the costs of owning an investment trust in their portfolio to their clients. And so that means that for anything other than very specialist trusts, wealth managers have basically been steadily exiting over the last two or three years because of these MiFID rules. And there's also quite, because a lot of the areas of specialism like private equity and real estate are areas which have quite high costs, but they also deliver quite – have delivered from time to time – quite high returns after those costs. And really, it's the returns after the costs rather than the costs per se. But because some of those specialists are high-cost funds, the wealth managers still haven't really returned to them, which is why there's a lot of political debate at the moment about trying to rationalize the requirement to show look through costs on investment trusts, whereas you don't have to show the look through costs on owning Marks & Spencer or Lloyds Bank. And if that can be solved, then I think it will help remove an artificial headwind to the sector. But the fundamental thing is going to be what happens to the assets.

The discounts have been widened for the reasons we've been discussing. But what really matters is, are you in an area where is this a fundamentally financially soundly based company doing something interesting at the right point in the cycle when it starts going up, and people think, hey, I want to have some more of this. And my hunch is I'm more bullish than some people. But I think we're at a turning point where when interest rates start falling, even if the economy is in lumber at the time, it's a different psychology because time is on your side, probably next year will be better than this year if interest rates are falling. Whereas when interest rates are going up, you're fearful that the next shoe is about to fall. So, I'm pretty bullish on markets generally. But I can be wrong at least half the time. And I think that once investor psychology moves away from being so risk averse, I think you'll see some flows coming into the sector and the discounts will help people who buy the right trust at discounts not always worth buying. You have to be sure that the asset base is okay. But I would be surprised if in the areas of widest discounts, there isn't a tailwind from narrowing in the next year or so.

OS: Sure. And if you take away one thing from that, it's that it's all about the assets.

AB: It is.

OS: Andrew, thank you so much for your time. For more on UK investment trusts, check out any of our editorial websites internationally, but of course, Morningstar.co.uk, for which I've been Ollie Smith. Goodbye.

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Ollie Smith

Ollie Smith  is editor of Morningstar UK

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