Q: How do ITs differ from Oeics and unit trusts?
Because of the stock exchange listing, investment companies are ‘closed-ended’, meaning that for every buyer, there also needs to be a seller.
In other words, the size of the company is generally fixed from the start, although new shares can be issued, with shareholder approval, to meet extra demand.
Open-ended funds, in contrast, can expand or contract in size according to demand.
Annabel Brodie-Smith, communications director of the Association of Investment Companies, said while it could be argued that the closed-ended investment company structure makes liquidity an issue for wealth managers and advisers who effectively ‘buy in bulk’, a significant proportion of the sector is more than able to cope with large volumes of demand.
Ms Brodie-Smith said the closed-ended structure is one of the investment company sector’s strongest advantages, because it allows managers to take a long-term view of the market without having to sell good stock to meet redemptions.
Another key advantage of the investment trust structure is the ability to store up to 15 per cent of income each year in revenue reserves.
This allows investment trusts with reserves to meet dividend commitments even when markets are performing badly, according to Ms Brodie-Smith.
Many investment companies have a long history of growing dividends with some having done so for 40 years or more, providing investors with a secure income at a time when capital growth is less certain.
The freedom to gear, or borrow, is very much a distinguishing feature of the investment company sector, as is the independent board and the stock exchange listing.
Indeed, Ms Brodie-Smith said one of the key things to remember is that investment companies were companies in their own right, owned by, and run solely on behalf of investors.
In extreme circumstances, Ms Brodie-Smith said if an investment company board is not happy with the performance, they can take the management contract elsewhere.
Some investment companies have actually dealt with the discount and liquidity issue in one fell swoop: In summer 2011 Ms Brodie-Smith said Personal Assets Trust had a ‘zero discount’ policy.
The board managed the discount to the extent that it trades at par – or close to the value of the underlying assets.
It simply issued new shares to meet new demand (or buys back shares if demand wanes).
* Pricing structure.
* Gearing or borrowing
Gearing (or borrowing) is another key feature of the investment company sector that sets it apart from open-ended funds. If performance is good, gearing will magnify the performance but, if performance is poor, losses will also be enhanced.