Why reforming the UK’s capital markets starts with fund cost disclosure rules

The start of the year has seen renewed focus on how we can make the UK stock market more competitive, and rightly so.

But left out of the broader conversation is the listed investment company industry, which has been grappling with issues surrounding fee disclosure rules.

These rules are most keenly felt among companies investing in illiquid assets, distorting costs relative to open-end funds and listed commercial companies, putting our UK listed investment companies at a distinct disadvantage compared to their international peers.

Enforced EU legislation has left us with an uncomfortable legacy, requiring UK listed investment companies and funds investing in them to disclose the costs of financing, operating and maintaining real assets such as real estate, infrastructure or renewable energy.

This is despite the fact that these charges are already published in regular company updates and reflected in the share price of all investment companies, and for investors it amounts to double counting of the charges.

There is double counting because ‘costs’ such as management fees, building maintenance and interest charges are included in the value of the share price, just as would be the case with any other listed operating company, with key financial data included in the share price recorded. report and accounts.

Similarly, it is a ‘double counting’ if funds (both active and passive) that invest in listed closed-end funds have to merge these regulated cost disclosures with their own costs, again because the costs have already been factored into the performance of the holding. and the value of the underlying holding company.

The average London-listed investment trust is at a discount to net asset value of 11.6%, with portfolios made up of illiquid assets such as real estate and private equity among the worst hit.

Like any publicly traded company, investors buy and sell at the share price, not the intrinsic value. The differences between the two can be significant, unlike open-end funds or ETFs. It has affected investor sentiment to such an extent that the disclosures could negatively impact investment decisions.

Reforming Britain’s capital markets is not possible without solving this conundrum, with the sector accounting for around 36 percent of the FTSE 250, according to the London Stock Exchange.

Rather than creating meaningful transparency, the rules have created distortions that in their current form could drive publicly traded fund companies to the NYSE.

The autumn statement saw the government take steps to resolve issues surrounding cost disclosure rules (thanks in no small part to Baroness Altmann and Bowles). But while the regulations are now in place, we run the risk of getting stuck.

That’s because, while the FCA has been granted forbearance measures so that closed-end investment companies and the funds that invest in them can provide additional cost breakdown and context, this does not help data providers or investment platforms (which use the aggregated amount of ongoing charges) .

Great work has been done by the London Stock Exchange and industry campaigners to build support for a meaningful solution, which has been supported by the AIC. This has resulted in over 300 signatories (including abrdn) to a joint industry letter submitted by the London Stock Exchange to HM Treasury on 10 January 2024.

This joint sector letter calls for the exclusion of listed closed-end investment companies from the definition of Consumer Composite Investments. The industry is proposing instead to provide better, clearer cost disclosure that better reflects the true costs of buying and selling investment companies.

None of these issues mean we are not optimistic about the long-term prospects for the sector – far from it. The investment company industry has weathered many ups and downs in its more than one hundred and fifty years of existence, and has not only survived, but thrived.

Competitiveness in the UK market

But we urgently need a solution for a sector that has seen incredible growth in alternative assets over the past two decades. The closed-end structure is well suited to the long-term assets that the UK government wants investors to support. More than two-fifths of listed closed-end funds are private market strategies.

The unique structural advantages of the closed end sector will remain a great opportunity in the future. But just as a great structure requires great people, it also needs a supportive and competitive regulatory environment. And that’s a conversation worth having.

Christian Pittard is head of closed-ended funds and managing director of corporate finance at abrdn.