Investment Trusts, also known as investment companies, do not generate as much publicity as the larger universe of funds, made up of OEICs and Unit Trusts, yet there are over 400 to choose from with assets of around £185bn.
Funds are usually the starting point for most investors when building a portfolio. However, investment trusts have some distinctive characteristics which can give them an advantage at times, but are they sleepy dinosaurs or a well-kept secret of the investment world?
Steeped in history
Investment Trusts have been around for a lot longer than funds. In fact the ‘grand-father’ of the sector, Foreign & Colonial (now simply F&C) Investment Trust, was established in 1868 and celebrated its 150th birthday last year. Many others have chalked up their centuries. Meanwhile, the first unit trust, M&G General, did not arrive until 1931.
The earliest trusts were set up to manage the fortunes of Victorian industrialists, particularly those from Scotland. Scottish American, for example, was launched in 1873 to invest in railways and other infrastructure in the US, then an emerging market. Others funded expansion in the colonies, such as British Empire Securities Trust, while some retain blue-blooded family connections such as RIT Capital; the Rothschild (family) Investment Trust.
How an investment trust works
Investment Trusts have a closed-end structure which means they initially issue a fixed number of shares and trade on the London Stock Exchange. To increase their shares in issue they have to undertake a rights issue or placing, like any other company.
The share price is determined by demand in the stock market and may move to a premium or a discount to the underlying Net Asset Value (NAV). In contrast, funds create or cancel units on a daily basis to satisfy demand and the price always equates to the value of the assets held. They are described as open-ended.
An investment trust’s managers are regulated by the FCA and accountable to an independent board of directors, which has the power to change under-performing managers. The board may also authorise the use of debt (or gearing). The amount is decided in conjunction with the portfolio manager, along with the trust’s objectives, and may change in response to the economic environment.
The pros and cons
Investment trusts are useful if you wish to invest in more specialist areas, for example private equity, property or biotechnology, particularly where liquidity can be a problem. Managers often unearth valuation anomalies in less liquid assets and the closed-end structure means they are not forced to sell when investors want to.
A key attraction is the reputation for delivering consistent income; investment trusts are permitted to set aside up to 15% of dividends to reserves during good times in order to preserve pay-outs in downturns, whereas funds have to pay it all out that year. Consequently, a number of trusts have impressive records of growing dividends; City of London
, have delivered 52 years of consecutive increases.
The ability to borrow (not all do) can increase the volatility of returns. Taking on debt may enhance returns in rising markets, but will magnify losses when markets fall. At the end of January 2019, according to the AIC (Association of Investment Companies), average borrowing by investment trusts equated to 9% of the value of their assets.
The investment trust’s discount or premium to the underlying value of the assets will be affected by whether the asset class is in or out of favour. Lack of demand means the discount may widen and losses may exceed the fall in NAV. This adds a little more complexity but the opportunity to buy a portfolio of assets at a discount can be compelling. The average discount was 3% at the end of January (AIC data).
As with all shares, there is a spread between the bid and offer price which has to be covered before you make a profit. Additionally, any trade will incur a dealing charge as well as stamp duty on purchases. Management fees on investment trusts are competitive though specialist mandates may incur higher charges.
Why Trusts can have a role in a diversified portfolio
The ability to focus on managing investments rather than cash-flows, and potentially enhance the NAV by buying back shares, makes investment trusts worthy of consideration. The wide range of investments available can provide useful diversification. For example, global trust Scottish Mortgage, a constituent of the FTSE 100, can have up to 25% (at time of purchase) in unlisted companies with exceptional growth potential.
Trusts tend to have experienced, high calibre fund managers as they are answerable to the board, and many spend much of their career in situ. Some run parallel open-ended funds and, on occasions, it may be possible to access better performance from the trust due to the features mentioned above and sometimes the flexibility of a more manageable size.
How to choose an investment Trust
Many investment trusts are managed by well-known fund houses even though they do not always carry their name. For example, the Baillie Gifford stable of trusts includes: Monks, Scottish American, Scottish Mortgage, and Pacific Horizons.
Morningstar provides analyst ratings for selected investment trusts on the Willis Owen Platform. You may like to investigate further some highly rated trusts which have popular open-ended equivalent funds: Mid Wynd International
(Artemis Global Select); Finsbury Growth & Income
(Lindsell Train UK equity); Schroder Japan Growth
(Schroder Tokyo); Edinburgh Investment
(Invesco Income) and Pacific Assets
(Stewart Investors Asia Pacific Sustainability).
In summary, given its long history through world wars, the great depression, periods of hyperinflation and the Financial Crisis, the Investment Trust sector seems well placed to deal with current uncertainties, and indeed could prosper over the next 100 years.
Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.