Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

Alliance Trust's new board faces an early test of its independence. The poorly performing U.K. investment trust, approached by Jacob Rothschild's RIT Capital Partners about a possible takeover, has a chance to demonstrate that its reformed governance can actually lead to gains for shareholders.

It's a year since Alliance Trust was forced by Elliott Advisors, a 10 per cent shareholder, to start revamping the board and to address longstanding performance issues. Chairman Robert Smith started in February. While the board is new, the causes of Elliott's grievance remain. Alliance Trust stubbornly trades at a discount to the underlying value of its investment holdings -- the gap currently is about 10 percent.

Mind the Gap
Alliance Trust's discount to net asset value narrowed in 2015 as shareholder Elliott pushed for change
Source: Bloomberg

Investment trusts are meant to be a neat way for investors to hold a portfolio of shares. The snag is that they often trade slightly below net asset value. When the discount becomes too big, a takeover by a better-managed peer can make sense. (RIT, by contrast, trades at a small premium to asset value.) In practice, it's often simpler to realize the underlying value by liquidating the portfolio.

The logic of RIT combining with Alliance Trust is plain: RIT could slash duplicate functions and manage the enlarged asset base of 5.3 billion pounds ($7.8 billion) at much lower cost. Until recently, it was hard to imagine proudly independent Alliance contemplating such a thing. But the new board has committed to "enhancing" shareholder value, and should be listening.

For Elliott, a deal would make it easier to sell down its stake. If it didn't take cash as part of a transaction, it would at least be invested in a larger, more liquid entity.

The merger plan is in the early stages but the potential pitch to other Alliance Trust shareholders is obvious -- the chance to switch into a better-run vehicle with a track record of share-price and net asset value appreciation that beats the MSCI All-Country World Index on a 10-year view.

A Close Alliance
RIT Capital Partners has narrowly outperformed Alliance Trust over the last decade
Source: Bloomberg

Alliance Trust shareholders will want to know that all the alternatives have been carefully weighed. These are winding up the trust and returning the proceeds; cutting costs; and outsourcing investment management.

There's no offer yet, but if it comes at Alliance Trust's net asset value, that would be a tough benchmark to beat. After all, liquidation has costs, so full net asset value wouldn't be achieved that way. The other remedies could take time to work.

Smith's very first comment after his January appointment was to talk up Alliance Trust's "long and proud" Scottish history and roots. That heritage would be at least diluted and perhaps sacrificed entirely in a deal. If Smith and the board really mean what they say, they'll have to abandon sentimentality and sanction change.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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