Investment trust sector accused of governance failures

Some boards shunned Quilter Cheviot's questions about their governance and engagement

The investment trust sector is facing calls for widespread reform after an investigation found some boards are falling below expected governance and engagement standards.

Wealth manager Quilter Cheviot met with the chairs and other non-executive directors (NEDs) of 41 equity investment trusts to carry out its research.

While most boards were receptive to questions about their governance and engagement processes, some were not.

In one case a board described engagement as ‘fatuous’ when asked to give more details about how it applies to the investment company.

Board composition, board effectiveness, and disclosures for environmental, social and governance factors, were all reviewed in the investigation, with Quilter Cheviot giving a red, amber or green rating based on its findings.

Only three out of the 41 investment trusts qualified for a green rating in each of the categories, while two received a red rating across the board.

Board effectiveness, at 70%, had the highest percentage of green rating. Nearly two-thirds (63%) of the boards achieved a green rating for composition and effectiveness.

Board composition generated the most red ratings, however, with seven trusts failing on this criteria, representing 17% of the trusts within this universe. 

Failure to meet diversity targets was the most common reason for the red rating for board composition.

Another reason was the presence of non-independent directors, or one or more directors, serving over the recommended tenure of nine years with no plans to resolve this, pointing to poor succession planning.

Nick Wood, head of investment fund research at Quilter Cheviot, said: “Investment trusts have grown in popularity over the years and for good reason, with a wider range of asset classes available and the increased liquidity benefits.

“However, when we invest in an investment trust, we become the shareholders of the company and, as such, our governance expectations are much higher than they would be for an open-ended fund. 

“As such, engagement exercises such as this are crucial to ensure we understand how investments are being managed on behalf of our clients, and crucially provide constructive feedback so we can see improvements over time.”

Quilter Cheviot wants to see several changes as part of an overhaul of governance and engagement in the investment trust sector.

In future board succession planning should be managed on an ongoing basis and an inability to do so is a “governance failure”, it said.

Diversity targets should include cognitive diversity, and to achieve this trust boards “need to rethink recruitment”, with the names of executive search firms and external evaluators to be disclosed in the trust’s annual report.

Individual non-executive directors (NEDs) should be assessed using a points-based system to see if they are sitting on too many board, with qualitative assessments used too, the wealth manager said.

Also while most NEDs would be expected to own shares in the trust, personal wealth “should not be a barrier for appointment”.

Boards should also reconsider which stakeholders should be engaged with through the external evaluation process, and responsible investment disclosure should be focused on the trust, not the firm’s approach.

Richard Stone, chief executive of the Association of Investment Companies (AIC), said: “Investment trusts’ independent boards of directors are important guardians of shareholders’ interests. Boards have been particularly proactive this year in their pursuit of shareholder value, proposing mergers, reducing fees and even proposing the winding-up of companies.

“Shareholder engagement is a critical component of good governance. We welcome Quilter Cheviot’s thorough engagement programme which explains their views, the rationale behind them and their recommendations. This is a valuable contribution from a leading wealth manager that is clearly committed to the investment trust sector.”