There are a number of factors investors should consider when choosing an investment trust.
Less experienced investors may focus solely on past performance; those with more experience may look into the resources behind the fund, including the skills the team brings and the process the fund manager follows.
One area that is often overlooked is the fund firm, or parent—one of the five key areas (alongside people, process, performance, and fees) that Morningstar analysts believe are important to understand when predicting the likely future success of funds.
They think the parent organisation is of utmost importance in evaluating funds. Although other factors may have a more immediate impact, it’s unlikely they would be sustainable over the long term without the proper backing from the asset manager.
Emma Wall: Hello and welcome to the Morningstar TV series, Ask the Expert. I'm here today with Morningstar analyst, Szymon Idzikowski, to talk about how he ranks Morningstar closed-ended funds. Hello.
Szymon Idzikowski: Hi, Emma.
Wall: So, there are five methods or areas that analysts look at when investigating funds, and one of them is stewardship. What exactly is that?
Idzikowski: Yes, so you are right, there are five – we sort of refer this as five pillars, right. So, this is people, process, performance, price, and in terms of investment trust, by price we mean the level of fees and fees structure rather than market price. The fifth one is the parent, and within the parent we can think of this as stewardship.
Wall: What exactly does that mean?
Idzikowski: So, when we think about the stewardship, we try to understand the sort of values the company brings. So, like I say, there are five areas, but we think that even though the other four might have a more immediate impact on the fund, they wouldn't be really sustainable over a long term without the backup from their parent. So, within the parent there is a number of areas we would look at to understand what sort of values the company brings, such as retention of talents within the company and hiring new talent, such as risk management or alignment of interests.
Wall: Have you got an example where this is the case?
Idzikowski: Sure. For example, in terms of alignment of interests, one area we evaluate is their remuneration structure. So, we would prefer to see that the remuneration is based on a longer term rather than a short term, which would align analyst and investment manager with the investors.
Wall: One thing that’s exclusive to closed-ended funds is the Board of Directors. Does this come under stewardship?
Idzikowski: It does, yes. We believe that investors should understand the sort of skills that the Board brings and whether they're active and whether they're going to bring – whether they’re going to take some action if it's necessary.
Wall: We've got one high profile case where the Board is being innovative in that case, haven’t we, in the Edinburgh Investment Trust?
Idzikowski: Correct, and this is actually quite interesting, because Neil Woodford, who is in charge of this fund, has just celebrated his fifth annual a couple of weeks ago. Before Invesco and before (Neil Woodford) had been appointed to this fund, the fund has been managed by Fidelity, and actually there was nothing wrong with the way Fidelity run it. It’s basically shareholders wanted the fund to have more prominent focus on the income. So, that's why the Board put the fund on tender and Invesco on it. So, this is exactly the sort of action we would like the Board to take to meet investors’ needs.
Wall: What about a third area?
Idzikowski: So, again, something we believe is quite important for investment trust is organizational and business structure. It's important because there is a number of self-managed and self-managed trust or trust managed by small boutiques. Since, such a situation the key man risk is higher and also there could be potentially ownership conflict. Just to give you maybe an example of that as well.
Nick Train, he is the fund manager of Finsbury Growth & Income, which we rate Gold, but at the same time he is one of the co-founders and one of the main shareholders of Lindsell Train, the fund house which runs Finsbury Growth & Income. So in such a setup you could argue there could potentially be conflict of interest for Nick Train and Michael Lindsell try to grow their business, grow their assets, and he did. Actually since they were on Finsbury Growth & Income, we’ve seen a number of new launches done by the fund house. However, all these launches have been done with their area of expertise which mutes our concerns. But like I said, at the same time there is key – there could potentially be key man risk and indeed…
Wall: Because there are so few people of the company.
Idzikowski: Exactly. So, for example, at Lindsell Train you've got four investment specialists; you've got two fund managers and you've got two analysts. So, if potentially there is a departure of one of the fund managers, that could have a very big impact on the fund or on the whole business.
Wall: So, in summary, it's important for investors then to consider the name or the company behind the name as much as the name on the front.
Idzikowski: Exactly.
Wall: Sztmon, thank you very much.
Idzikowski: Thanks for having me.
Wall: This is Emma Wall for Morningstar TV. Thank you for watching.
