Investment trusts have a rich heritage, having existed for more than 140 years. They make up no small part of the investment markets: according to the Association of Investment Companies (AIC), more than £95bn is currently held in closed ended investment companies.
With the date for implementation of RDR rapidly approaching, advisers looking to remain independent must take a whole of market approach when considering investment options. Investment trusts potentially have an important role to play in this, as advisers consider how best to manage clients’ portfolios.
There are more than 400 investment trusts listed on the London Stock Exchange, but this is less than a quarter of the number of open ended investment companies (OEICs) available. That said, the investment trust sector is hugely diversified and covers all manner of things from property to below radar small caps.
What exactly are they?
Investment trusts are closed ended publicly listed companies. They have a fixed number of shares in issue, apart from instances of exceptional circumstances such as buybacks. Each share has a net asset value (NAV), based on the value of the underlying assets, but the share price can go up or down depending on investor demand.
Typically, investment trusts have boards that are independent from the investment manager to keep an eye on shareholders’ interests. The income from trusts can be distributed to shareholders as dividends and the individual shares can grow in value. Gearing of up to 10% of assets is permitted, allowing managers to borrow cash to fund conviction investment in key areas.
Wide choice
Investment trusts have traditionally been sold without commission, making it difficult for advisers on commission based remuneration models to incorporate them. The RDR is opening up investment choices with the removal of commission, creating a far more level playing field for all available investment vehicles.
Aside from the obligation to consider investment trusts as part of a whole of market approach, there are a number of reasons why they should be considered in their own right.
Management charges are low, usually far lower than achievable in OEICs. According to the AIC, almost a third of investment companies have total expense ratios (TERs) of below 1%, nearly two thirds below 1.5%.
Low management fees are more common in passive investments, but investment trusts provide active management at a low cost. This makes them an attractive option for those looking to keep down costs but do not wish to go down the passive management route. Low fees have contributed to many trusts’ long term performance.
Additionally, the investment trust structure means that management is focused on defined criteria. As listed companies, they are beholden to shareholders and have a board that decides how the trust should invest. This can only be altered with the consent of shareholders.
The presence of a board introduces a stringent level of accountability into the investment; if a strategy is not working, it can be addressed. Every year, the board must assess whether the investment manager should be reappointed and give reasons for doing this, meaning that a poorly performing manager can be removed.
Additionally, the closed ended structure means that managers have a fixed basket of assets to deal with and do not have to contend with inflows and outflows.
The option to gear, although in one sense an added complexity, gives investment trust managers more freedom to enhance shareholder returns. Again, this needs shareholder approval.
How to use them
Investment trusts have a range of uses appropriate to different types of investor.
Some trusts are very ‘generalist’ and highly diversified, making them ideal candidates for core holdings. At the other end of the scale are sector specific investment trusts allowing access to areas like emerging markets and natural resources.
The structure of investment trusts makes them a good income generating option, something particularly noteworthy at a time of record low interest rates. There is scope for regular income through rising dividends, supplemented by investment trusts’ ability to reserve up to 15% of annual income to potentially supplement income in more difficult years.
This makes them an option for income drawdown clients and anyone needing regular income for payment of school fees or care fees.
Investment trusts can also be used to try to capture growth, particularly in the case of highly geared investment trusts amplifying returns in rising markets. Such strategies come with higher risks, however, so this approach is more suited to those focused on growth with a bull view in a particular area.
Also worth noting is that investment trusts have almost unlimited scope for the range of investments that they can purchase. This means that sectors such as private equity and unlisted investments can be incorporated for investors with a high risk appetite.
A further way of accessing investment trusts is through a fund of funds specialising in them, giving access to an even greater range of investments.
Cutting complexities
Lack of knowledge can be prohibitive to investing in any type of vehicle so it is vital that advisers have a clear understanding of what investment trusts are.
One issue is their perceived complexity. The concept of a share price being driven by demand rather than portfolio value may be less familiar, but once grasped can actually be used to investor advantage, for example, buying shares at a discount to capture profit when the price rises.
The basic premise is that the NAV represents the trust’s net assets divided by the number of shares in issue. The share price depends on investor demand: when shares are in high demand and the price is driven above the NAV, shares are said to be trading at a premium; when there is low demand and the price is below NAV, they are trading at a discount.
The volatility associated with investment trusts needs to be accounted for. They are usually more volatile than comparable OEICs because they are listed on the stock exchange, meaning that they are more appropriate as part of a long term investment strategy.
Education, of course, is key. No adviser would want to recommend a product that they did not fully understand, but getting to grips with investment trusts opens up a whole range of ideas as alternatives or indeed complementary to OEICs.
Chicken and egg
A commonly heard argument – and a most valid one – from advisers is that investment trusts are more difficult to access than other types of investment due to their lack of availability on platforms. While platforms will argue that this is due to a lack of demand, somebody ultimately has to make the first move.
This is something of a chicken and egg situation but the coming of RDR should help to even things out. Already, Fidelity FundsNetwork has confirmed its plans to list investment trusts by the end of the year and CoFunds is expected to do so post-RDR.
Advisers interested in investment trusts must make platforms aware of their desire for them in order to convince platforms to make them a strategic priority rather than putting them on the back burner.
Once investment trusts are more easily available and given equal prominence to other vehicles, advisers will be able to compare them more easily and see where they might fit in clients’ portfolios.
The future
Many have predicted that, come the RDR, investment trusts will become more attractive to advisers. This is down to a combination of factors: the removal of commission on investment products; investor appetite for low cost funds as fees come to the fore; and an envisaged enhanced availability of trusts on platforms, where many advisers conduct a vast amount of their business.
None of this can happen unless advisers see the value of investment trusts and this begins with a full understanding of how they work, what they do and how they can be used. The unique selling points of investment trusts, while at first might seem an added complexity, can actually add value for clients if they are used in the right way.
David Barron is head of investment trusts at JP Morgan Asset Management
