At the upcoming general meetings, the shareholders of abrdn Smaller Companies Income Trust plc (ASCIT) and Shires Income plc (Shires) will be asked to make a decision on whether to accept a merger between the two trusts. Mergers have become commonplace across the investment trust industry, but they are understandably destabilising for investors. They may have chosen the trust carefully and held it for a long time. However, a carefully considered merger can add real value for shareholders.

As such, the first question may be why mergers need to happen at all. Isn’t it easier to leave well alone? Investment trust boards always need to look at whether they provide value for shareholders and that includes whether trusts are run efficiency, have sufficient liquidity and have sufficient flexibility to achieve their investment mandate successfully.

In the case of ASCIT, the board had been concerned about the small size of the trust, relatively poor liquidity and its persistent discount to net asset value. These had been contributing factors to a more difficult run of performance and had led the board to consider a range of potential options for its future. As one of the largest shareholders in the trust, Shires had been part of these discussions. Having considered a range of merger or acquisition choices, the combination of Shires and ASCIT seemed to serve the interests of both sets of shareholders and to ensure ongoing relevance and differentiation in a crowded marketplace.

Lower costs

There are clear cost benefits to larger trusts: trusts always incur fixed costs and combining two allows boards to spread those costs over a larger asset base and bring cost reductions to shareholders. This is particularly true for ASCIT shareholders, where costs will fall over 30%, including a much lower base management fee.

Larger trusts typically have greater liquidity, making it easier for investors to move in and out. They can also appeal to a wider shareholder base, including wealth managers. Wealth managers have become an important buyer of investment trusts in recent years, but often won’t look at smaller trusts because they need to deal at scale. Combining trusts can therefore be an important factor in creating long-term, sustainable demand for a trust’s shares.

In the case of ASCIT and Shires, the ASCIT shares have traded on a persistent discount to net asset value, while Shires – the larger trust – has historically traded at a narrow discount or even a premium. This is a reflection of its better long-term performance, which is partly attributable to the breadth of its investment universe, rather than simply being confined to smaller companies. The discount for ASCIT has already narrowed in response to the announcement, which we see as an endorsement of the combined strategy.

Responsible boards always need to consider whether the trust is serving its shareholders efficiently and take steps to improve where it isn’t. Trusts need sufficient scale to build a successful profile, keep costs low, deliver greater liquidity and be managed as efficiently as possible. Appropriate mergers between like-minded trusts can be part of good governance. This merger sees low frictional costs, helped by abrdn’s contribution to the costs of transitioning the portfolio.

ASCIT and Shires

In addition to these general factors that support mergers between trusts, there will also be factors specific to individual trusts. In this case, we believe the ASCIT shareholders will appreciate the dividend uplift. The dividend should increase by around 45% - the current yield for Shires is 6%.

Shareholders in the combined group will still see the benefit of the growth potential of smaller companies, which will form around 20% of the combined trust portfolio, but with greater stability of income as a result of Shires’ weighting in preference shares and larger companies.

Combining the two trusts also allows for continuity of management. The management of the trust will be led by Iain Pyle, supported by Charles Luke, and bring in expertise from the current ASCIT managers Abby Glennie and Amanda Yeaman. For Shires shareholders, we believe the move to invest directly in smaller companies rather than through a trust will minimise volatility and allow more targeted and flexible investment in this part of the market.

To our mind, the combined trust has a compelling proposition. At a time when investors need their income to keep pace with inflation, the income profile of the combined trust should be appealing, balancing growth and stability. This is important at a time when income may be more abundant, but growth in that income remains scarce. The structure should allow the management team greater agility to deliver returns, while also creating greater efficiency and cost savings.

That said, while these are great reasons to stick with the trust, all boards need to recognise that the combined option won’t be for everyone and offer alternatives. In ASCIT’s case, some investors will want dedicated small cap exposure, for example, and for those investors, there is a cash option at a 0.8% uplift on the NAV.

Mergers may seem destabilising in the short-term, but they can be an excellent way to realise value in investment trusts and create stronger, more scalable trusts, fully fit for the future. This is a well structured transaction, that should produce an outstanding result for both sets of shareholders.

Discrete performance (%)

Total return; NAV to NAV, net income reinvested, GBP. Share price total return is on a mid-to-mid basis. Dividend calculations are to reinvest as at the ex-dividend date. NAV returns based on NAVs with debt valued at fair value. Source: abrdn Investments Limited, Lipper and Morningstar.

Investment objective: To provide shareholders with a high level of income, together with the potential for growth of both income and capital from a diversified portfolio substantially invested in UK equities but also in preference shares, convertibles and other fixed income securities.

Important information:

Risk factors you should consider prior to investing:

• The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
• The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
• The Company may charge expenses to capital which may erode the capital value of the investment.
• There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
• Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
• With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘subinvestment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
• Yields are estimated figures and may fluctuate, there are no guarantees.

The Key Information Document (KID) for the Trust can be found on the Literature page of the Trust’s website: www.shiresincome.co.uk/literature

Other important information:

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.

Find out more at www.shiresincome.co.uk or by registering for updates. You can also follow us on social media: Twitter and LinkedIn.