View from the top: Frostrow Capital's Alastair Smith and Grant Challis
Frostrow Capital, established in 2007, now has £5.7 billion of assets under management.
Its four flagship trusts - Money Observer Rated Funds Finsbury Growth & Income, Pacific Assets and Worldwide Healthcare, along with Biotech Growth Trust - are some of the best-performing trusts in their respective sectors, notching up top returns as if these were simply par for the course.
Despite this, very few know exactly what it is that Frostrow does. This is because most trusts still tend to be run and managed under the banner of large investment houses under an outsourcing model - JPMorgan or Baillie Gifford, for example - or run in-house by the trust itself, as in the case of Alliance Trust and The Scottish Investment Trust.
And that is exactly the reason that founders Alastair Smith and Grant Challis decided to set up Frostrow, which administers, monitors and markets investment trusts independently of both the portfolio manager and the board.
CONFLICT OF INTEREST
'Investment trusts are meant to be independent from the investment manager. There is a dynamic between the board and the manager and when everything is going well, everyone is happy, but when there is a change needed that's when life can get difficult,' says Smith.
A trust board can find this a challenge. 'Think about it,' he says. 'If you employ JPMorgan to run and manage your trust and you're not happy with JPMorgan, the only people you can talk to about that are people in the employment of JPMorgan. Effectively you're asking: "JPMorgan, help me to fire you."'
This, argues Challis, creates a fundamental conflict of interest. He and Smith witnessed first-hand the problems it caused when they were employed in the investment trust administrative team at Close Brothers Asset Management.
Back then, Biotech Growth was managed by Close, and Challis recalls the uncomfortable process of ousting internal Close managers in favour of the current manager, Orbimed.
'The only way we were going to secure the future of that trust was to move to an external manager, and that was not in the interest of Close Brothers, so we had to manage that conflict internally,' says Challis. Close did finally agree to relinquish control of Biotech Growth's portfolio while holding onto the administration side.
Smith and Challis saw the opportunity for an independent, 'clean' vehicle that could provide good governance by working with any trust and any investment manager to protect the interests of both parties without such conflict. Thus, Frostrow was born.
GLUE IN THE MIDDLE
According to Smith, Frostrow is best described as the 'glue in the middle' of their trusts; while star managers are (rightly) busy picking stocks, Frostrow is active making the trust function.
Smith says: 'Whenever you read anything on funds, it's always about the managers - Nick Train says this, Sam Isaly says that. But for an investment company to exist, a lot more is needed. Someone has to employ the manager, raise initial capital, and promote and market a vehicle. That's what we do: we provide the infrastructure within which trusts can exist.'
On a day-to-day basis, this involves attending board meetings, staying in close contact with directors, and advising on regulation and compliance. The latter, explains Challis, is one of Frostrow's unique selling points.
After intense regulatory scrutiny and spending almost-bankrupting sums of money, the firm is now a regulated alternative investment fund manager (AIFM). The fact that every trust now needs an AIFM under EU rules makes Frostrow even more attractive to trust boards.
This, combined with Smith's and Challis's years of experience managing and marketing trusts, has helped Frostrow bag contracts with three other big-name trusts: Witan, Electra Private Equity and Fundsmith Emerging Equities. The firm acts as company secretary for Witan, and secretary and board adviser for Electra and Fundsmith Emerging Equities.
In terms of what the firm offers private investors, both Challis and Smith argue that the governance model is highly beneficial.
Principally, investors can be assured that Frostrow is looking after the interests of their trust - and therefore investors' interests - above all else, and especially above the interests of the portfolio manager. In addition, Challis argues that Frostrow's active marketing effort adds value for individual investors.
He says: 'We are very active in marketing our trusts to the right organisations. Combined with strong portfolio performance, the result is that they trade either on slight premiums or very narrow relative discounts. There has been constant demand, the trusts have got bigger, average costs have fallen and they trade better.
'In the case of Biotech Growth and Worldwide Healthcare, they also have a more diversified shareholder register than they had five years ago. Instead of big institutions holding chunky stakes that can be bought and sold in a week, it's much more fragmented, so any selling won't have a huge impact, which reduces discount volatility.'
Challis and Smith observe that this fragmentation of shareholder registers has a lot to do with the rising popularity of investment trusts among private (retail) investors.
They say the number of retail investors on the register of Worldwide Healthcare has increased by close to 20 per cent over the past three years. While this includes discretionary fund managers and wealth managers - who transact on behalf of private clients - the wider trend is clear.
Challis says: 'The rise of the educated investor has been phenomenal. For example, Hargreaves Lansdown has come from virtually nowhere five years ago to be the top holder on some of our trusts, and that's not because we asked it to place some stock down its channel.
'These are private parties who read articles and make their own decisions about investing, and that's completely changed from five years ago.'
Challis and Smith currently have their hands full with their latest trust launch, Menhaden Capital - the brainchild of Ben Goldsmith, Goldsmith family scion and founder of environmental asset manager WHEB. Menhaden will invest in assets that 'deliver or benefit from the efficient use of energy and resources'.
At the time of writing, Menhaden was targeting £150 million in its initial capital-raising effort and was due to list on the London Stock Exchange on 31 July. Frostrow will act as a full-service AIFM to the trust.
However, while the launch presents an exciting challenge, Challis and Smith insist getting new trusts onto the market is not a priority.
Smith says: 'We are providing a highly tailored service for our clients and we're not willing to sell ourselves short, so the moon and the stars have got to line up for us to attract and take on a new client.
'People focus on size, but while of course we want to grow the business, we are not desperate to grow it. We don't want to compromise the work we do for current clients and investors.'