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Throgmorton, we need bold buybacks not fiddly fee changes

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Throgmorton, we need bold buybacks not fiddly fee changes

BlackRock Throgmorton (THRG), a £310 million UK smaller companies fund, has made some complicated changes to the way it pays its fund managers in the hope that doing so will make its shares more attractive. I’m not convinced.

Throgmorton’s problem is that despite delivering good performance, shares in the investment trust have spent much of the past 10 years stuck on a double-digit discount below net asset value (NAV).

Of course it’s not the only smaller companies trust plagued by discounts: although the AIC’s is packed with great long-term performers, only one of the 19 trusts trades at a premium above NAV, the recently launched Downing Strategic Micro-Cap (DSM).

But Throgmorton’s discount is big: currently, the stock stands 17% below its portfolio value, wider than both the 12% sector average and the 14% discount on stable mate BlackRock Smaller Companies (BRSC), which its lead fund manager Mike Prentis also runs.

Something clearly needs to be done to ensure shareholders get more of the portfolio return that Prentis and co-manager Dan Whitestone generate. The question is: what?

Manager incentive

Having spoken to the trust’s biggest shareholders, including wealth managers Investec, Brewin Dolphin and Rathbones, the board, chaired by Crispin Latymer, has come up with an answer. It has decided to halve the base annual charge shareholders pay BlackRock and hike the outperformance fee Prentis and Whitestone can earn when they beat the Numis Smaller Companies excluding AIM index.

The board’s thinking is that incentivising the fund managers to do better should result in improved shareholder returns, which will make the stock more attractive to buy and thus narrow the discount.

‘The low base fee minimises the costs borne by shareholders whilst the performance fee is designed to reward the manager at a level acceptable to shareholders for the generation of superior performance,’ Latymer writes in the trust’s half-year results published today.

His logic is impeccable. The trouble is that tinkering with fees can soon get very complicated, particularly when you try to make them fool proof.

Devilish detail

Slashing the annual management charge from 0.7% to 0.35% from next month looks simple enough at first, but it does not mean the trust will match the sector’s current lowest charger, Henderson Smaller Companies (HSL), which also levies 0.35%.

That’s because while Henderson takes its fee on net assets, excluding gearing, or borrowing, Throgmorton’s fee continues to apply to gross assets. This includes the gearing of up to 30% from Whitestone’s side portfolio of contracts for difference (CFDs, a form of derivative that allow him to go ‘long’ and ‘short’ on stocks he likes and dislikes). Analysts at Numis Securities estimate this would be the equivalent of 0.46% of net assets.

Things are equally niggly on the performance fee. Here the board has agreed to pay BlackRock a higher proportion of the excess return it achieves when the fund’s portfolio beats the Numis benchmark. From December the fund manager will get 15% of the outperformance, up from 10%, but will have to do so over two years rather than just one year as before.

Similarly, a cap on how much it can earn from this arrangement has been lowered to 0.9% from 1% of gross assets, again measured over two years compared to one year previously.

The extended time period is a good change, as is a double lock to prevent the charges running away and being too lucrative for BlackRock. This sees an overall cap on base plus performance fee lowered to 1.25% from 2%.

Unfortunately, a bad change is that the performance fee will apply in full even if the fund’s NAV falls but still beats the index. A protection introduced two years ago that halved the fee if the portfolio dropped in value appears to have gone this time.

AIM change

One last point on the performance fee is the index used to judge BlackRock’s performance. Throgmorton confirmed today it was raising the limit on AIM stocks from 25% to 35% of gross assets. That might mean changing the index to the Numis Smaller Companies including AIM, which historically has been easier to beat. I reckon that could mean further tweaks to the fee arrangements as early as next year.

I don’t know about you but my head hurts re-reading what I’ve just written! The drawback of all this fine tuning with fees is always that it makes the costs of different trusts difficult to understand and to compare.

Even more importantly, I doubt what Throgmorton is doing will make any impact on the discount. I suspect Throgmorton has a lower rating than some of its rivals because the presence of the CFD pool – alongside Prentis’ conventional smaller company portfolio – makes it more complex and therefore less appealing to investors. Rival smaller company trusts have star managers and simpler propositions: eg, Henderson (Neil Hermon), Standard Life (Harry Nimmo) and Aberforth (an excellent but lower profile team of partners).

Also, Throgmorton has undergone a couple of manager changes in the past three years with the departures of Richard Plackett and Ralph Cox and that may have unsettled investors.

Question of buybacks

Besides, if Throgmorton’s board is so anxious about the discount why doesn’t it buy back its shares? Share buybacks are a long established way of amending the supply-demand mismatch that the discount demonstrates.

Despite annual reiterations in its annual report that buybacks are always considered, Throgmorton hasn’t conducted any since BlackRock replaced AXA as fund manager in 2008. Now it is true, smaller company trusts aren’t renowned for share buybacks. Currently, Aberforth and JPMorgan are the only ones regularly purchasing their stock.

However, the issue is more acute for Throgmorton, which in 2010 dropped a key discount control mechanism when it removed a commitment to give shareholders a chance every six months to sell their shares in a tender offer priced at 2% below NAV and exit costs.

At the time Throgmorton defended its decision by saying its largest shareholders were worried that repeated tenders would diminish the trust and make its shares more difficult to trade. That is always the argument against tenders, but does it hold water for Throgmorton today, given the trust has more than doubled in size in the past seven years?

Back then more discount hunters, such as Laxey Partners and Weiss, were on Throgmorton’s share register than today, although recent buying by Wells Capital Management, which has a 5% stake, suggests the board cannot be complacent as pressure for more assertive measures might increase.

While buybacks aren’t common in smaller company trusts, the sector is not without its innovators. One has only to look at the turnaround in Invesco Perpetual UK Smaller Companies (IPU) since it hiked its dividend and promised a tender offer this year to see that more can be done about discounts than fiddling with fees.

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