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The views expressed in this article are those of its author and not necessarily those of ShareSoc.
Salutary Lessons for Directors and Shareholders of Trusts Investing in Alternative Assets
Usually, the role of non-executive director at an investment trust is a bit of a sinecure. Most investment trusts invest in stocks and bonds. Their portfolios are easy to value and there is little scope for misdeeds. Most such trusts publish their NAVs daily. The principal role for NEDs of such trusts is to negotiate fees with the investment manager, on behalf of shareholders; ensure that the manager is sticking to their mandate and performing competently; to review and sign off company accounts provided by the manager; to appoint and direct auditors; and to appear before shareholders at AGMs. Auditing the accounts of such a trust is relatively straightforward: you just need to verify that the assets stated are properly held; that their valuations match market prices; and that any debt is also correct. All of these are easily established for quoted stocks and bonds.
The role is rather different and more onerous at trusts investing in “alternative assets”, as the rest of this article will illustrate.
Two “Alternative” Trusts I Invested In
I invested in two “alternative” trusts, at their launches in 2020 and 2021. Both had attractive prospectuses and offered investments in assets with good ESG credentials. Suspecting that these trusts would soon move to premium ratings after their launch (due to the popularity of such investments), I applied for oversized positions with a view to “stagging” the issues. Fortunately, I did this, reducing my positions in the months following launch. I did not want to maintain significant positions until launch capital had been deployed and the trusts had proven themselves.
The first was Home REIT (HOME), which offered investment in housing for the homeless, with rental income derived from housing benefit payments made by local authorities.
My second investment was in Thomas Lloyd Energy Impact Trust (TLEI). This trust offered investment in renewable energy projects in Asia.
What Happened?
Both trusts seemed to be delivering on the promises made in their prospectuses until…
In the case of Home REIT, a short report was issued by Viceroy Research. This made some very serious allegations regarding the company. See this article for further detail. A subsequent investigation, initiated by Home REIT’s board, suggests that many of the allegations were accurate.
In the case of TLEI, out of the blue, the company announced the suspension of its shares, due to the discovery of a material uncertainty in the value of certain assets on 24th April 2023.
How did the Trusts’ Boards React?
In light of the above events, both trusts’ boards found themselves in difficult positions, with serious challenges on their hands.
Home REIT’s board were a little slow off the mark, initially defending the company and its advisers against the allegations made. To be fair, I also thought the allegations were probably exaggerated and was, initially, prepared to give the company and its advisers the benefit of the doubt (to some extent). The short report was issued on 23rd November 2022, but it was not until January 2023 that the board appointed forensic accountants Alvarez & Marsal to investigate the allegations. It was not until 15th March that the board advised that it was seeking an alternative to the previous investment adviser, Alvarium.
TLEI’s board, on the other hand, seemed much firmer with their investment adviser, ThomasLloyd (TL), announcing on 6th June that it intended to adjourn its AGM before a vote was taken on a continuation resolution. Were the continuation vote to pass, it would be difficult to displace TL. Extraordinarily, TL retaliated by requisitioning an EGM to vote specifically on the continuation resolution. Fortunately, shareholders backed the board and the continuation vote failed. This did not deter ThomasLloyd who have now requisitioned a fresh EGM, seeking to eject the board.
Clearly there has been a major falling out between TLEI’s board and the company’s investment advisor, with press releases flying from both sides. It is good to see TLEI’s board doing its job and standing up for the interests of the company’s shareholders, even if that means upsetting the apple cart with the company’s investment advisor.
In response to the board’s RNS of 15th August, TL issued this press release, which includes this extraordinary statement:
“…we fail to understand why the TLEI Board, as a non-executive board, would expect to see the Investment Manager’s internal working documents (including presentations and financial models).”
This is precisely the sort of information that a diligent board should expect to see! And the board responded to TL’s statement, as follows:
“The Investment Manager appears to misunderstand its key role and relationship with the Company if it does not see why material information should be provided to the Board. The Investment Manager should be reminded that it has been given delegated portfolio management responsibilities while the Board’s role is to provide oversight of these services for, and act in the best interests of, shareholders. For the Board to discharge its duties, it requires, in a timely manner, all information in the Investment Manager’s possession that may have a material impact on the Company’s financial position and prospects, allowing it to comply with its obligations, including its announcement obligations under MAR.”
Spot on!
Lessons for Directors of Investment Trusts and for Shareholders
The tales of these two investment trusts are instructive for directors of trusts holding alternative assets and for shareholders investing in such trusts. They demonstrate that the directors of such trusts need to do much more due diligence than those of “vanilla” trusts and need to be prepared to deal with the fallout, in the event of failures by their investment managers.
Investors in such trusts need to be very cautious until an “alternative” trust has established a long track record of delivery and, significantly, should expect to pay higher fees to directors of such trusts, considering the extra work those directors need to do and the risks they are taking (in terms of potential time commitment and stress). We should also seek highly experienced and independent-minded directors for such trusts.
Mark Bentley, Director, ShareSoc
DISCLOSURE: The author holds shares in Home REIT and Thomas Lloyd Energy Impact Trust
Post Date: September 9, 2023
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Very good points in this article.
I really don’t understand why so many of these alternatives (batteries, wind farms, solar farms) are held via the Investment Trust vehicle instead of just being set up in an ordinary commercial company. By setting it up as an investment trust, then IFRS10 is used and all the assets are marked at “fair value” – meaning often the underlying operating metrics (eg cash flow, depreciation and EBITDA), which I would like to understand if I were invested in for example a battery storage entity, are hard or impossible to ascertain from the accounts.
That’s also a good point, Sam. I guess one reason that these assets are held in investment trust structures is the tax advantages that investment trusts enjoy. Were they held by an ordinary listed company, that company would be subject to corporation tax. Since the withdrawal of dividend tax credits, that means that investors would be taxed twice: once at the corporate level, on profits, and again, at the personal level, on dividends.
You’re right though that the accounts of these investment trusts are pretty opaque.
I respect Mark and I sympathise with his losses from these investments. Of course we all make mistakes. This article is very well written. But I question this statement: ‘…Home REIT (HOME), which offered investment in housing for the homeless, with rental income derived from housing benefit payments made by local authorities.’
The rental income did not come to Home REIT from housing benefit payments. Home REIT did not grant tenancies to individuals on benefits, and if it had done this the benefits would usually have been paid to the claimants who would then have remitted their rents to Home REIT – or at least one hopes they might have done (many private landlords would tell you that this is not a reliable source of income). What the REIT did was grant leases (actually the same thing as a tenancy) to third parties, interposed between the REIT and the occupiers who were in effect sub-tenants. These third parties were charities (in some cases unregistered), housing associations, and community interest companies. Anyone can set up a CIC, it costs a few hundred pounds and takes very little time. The REIT’s prospectus claimed that this made Home REIT’s income more secure than if it granted tenancies directly, but in fact this was a false claim and the arrangement was the achilles heel of the scheme because many of those third parties turned out to be very bad tenants indeed.
The lessons from Home REIT extend beyond the particular line of business in which it was engaged and the point I want to make, as someone who has been in the property game for over 60 years in various roles, is that one of the absolutely key questions for any income-producing property investment is: Who are the tenants? In the old days of 25 year full repairing and insuring leases what every landlord wanted was an “undoubted covenant” – a tenant who would be willing and able to pay their rent in any conceivable circumstance for the full term of the lease. Nowadays landlords must set their sights lower, but it is still the case that in any property investment, including REITs, it is essential that one knows who the tenants are and has assessed their creditworthiness.
By the way, two days ago the goverment published a paper which reminds us that the penalty for conviction following a prosecution for failing to prevent damp or mould in a home is a potentially unlimited fine set by the Magistrates’ Court or a financial penalty of up to £30,000 set by the local council. This paper says:’We are absolutely clear that it is totally unreasonable to blame damp and mould in the home on ‘lifestyle choices’, which means that it is never the tenant’s fault, always the landlord’s. From what I have seen of the Home REIT portfolio this and the requirement to achieve an EPC rating of “C” by 2028 (confirmed by Baroness Scott of Bybrook in the Lords last Wednesday) would have been crippling even if the structure of the business had been better.
https://www.gov.uk/government/publications/damp-and-mould-understanding-and-addressing-the-health-risks-for-rented-housing-providers/understanding-and-addressing-the-health-risks-of-damp-and-mould-in-the-home–2#legal-standards-on-damp-and-mould-in-rented-homes
https://www.parallelparliament.co.uk/lord/baroness-scott-of-bybrook/dept-debates/DLUHC/parliament/2019#:~:text=fewest%20decent%20homes%3F-,Baroness%20Scott%20of%20Bybrook%20(Con),fuel%20poverty%20grant%20under%20review.
Thanks Michael,
Interesting input.
My statement regarding income derived from housing benefit payments was based on this statement in Home REIT’s prospectus:
I did not intend to imply that Home REIT received or expected to receive housing benefit payments directly.
Shareholders had no realistic way of assessing the quality of the covenants, or the refurbishment status of the properties associated with the acquired property portfolios – and the board clearly failed to do so, until after deficiencies came to public light. This is the nub of the point I tried to make in my article: shareholders require boards of such trusts to do much more due diligence than is required of boards of “vanilla” trusts. The covenants were supposed to be sound and the properties were supposed to have already been refurbished to a high standard (where necessary) on acquisition. Clearly this was not the case.
One of the reasons that I found the short report hard to take at face value, initially, was that I found it hard to believe that none of: the board, the auditors or the valuation agents had uncovered these blatant failings.
Best, Mark