Investment trust liquidity: Much ado about nothing?

A recent study by the Association of Investment Companies (AIC) shows positive signs for the industry. In the first wave of research in December 2011 and February 2012, of the 204 IFA respondents, 67 per cent said they were preparing to increase their allocation to investment companies over a period of six months to three years. The figure increased to 74 per cent in the second wave in September 2012.

But what were the key motives for advisers to increase allocation to investment trusts? A total of 54 per cent said the low-cost active management of the sector is key, while 34 per cent of respondents cited proven performance record and 33 per cent chose the fund range.

Despite this, one of the key barriers for advisers has been clear from the offset: liquidity. The biggest barrier to entry for investment trusts was concerns over fund liquidity for 49 per cent of advisers in the survey. Gearing was another key concern at 48 per cent, although 64 per cent of advisers cited it as the largest benefit of the investment company sector.

One of the key barriers for advisers has been clear from the offset: liquidity

Prior to implementation of the RDR, a primary concern for investment trusts – and therefore advisers when assessing their suitability for clients – was liquidity or the ease with which investors can trade shares. Investment trusts have a limited amount of shares and while it may be easy to buy the vehicles, it can be much harder to sell.

Investment trust advocates reject the idea, claiming closed-ended funds are able to issue new shares or buy back shares, which subsequently helps improve liquidity.

Phantom issues

Despite there being no clear correlation between total value traded and investment trust performance, liquidity still remains a hot topic with advisers and investors.

For James de Sausmarez, head of investment trusts at Henderson Global Investors, liquidity is an issue he is very conscious of but, as closed-ended managers, it is something he is keen to encourage as well. “There are a lot of trusts which have flexible share buy-back policies and flexible share-issuance policies,” he says. “The demand can be met and dealt with and there is not a problem with liquidity, you just need to be alert to the issue and look to managing it well.

“It would be more simple if the business of pricing, buying and selling were scientific but unfortunately it is not. One of the problems with investment trust trading is that it is not a science – it is an art – and it never works out exactly the way it ought to work.”

Mr de Sausmarez says liquidity is not an issue for the average investor. Advisers can put a small deal through for a client and they can guarantee to execute it for you, he says. However, buying in larger sizes is where it becomes more difficult. “If you want to buy £2m of shares in one particular trust, it may be easy depending on the size of the fund. However, wanting to put £2m of shares in smaller funds might not be so easy to execute,” he explains.

One of the biggest liquidity issues in the post-RDR world comes down to adviser dealing. “If you are a big intermediary or discretionary manager looking after money for your clients and you want to make an asset allocation decision involving several million pounds, then doing it in investment trusts can be hard. That is why a lot of the fund-of-funds managers prefer to deal in open-ended funds where they can get in and out easily,” says Mr de Sausmarez.

While agreeing that liquidity is not so much an issue for the average investor but for the larger institution instead, head of investment trusts at BlackRock, Simon White, thinks liquidity in investment trusts is not necessarily a negative. As advisers are looking at a more multi-asset approach for clients, investment trusts are a good place to gain access to more illiquid areas, he says.

“One of the great benefits of closed-ended funds is that they are able to take large illiquid assets and enhance the liquidity of them to create a diversified portfolio,” Mr White says. “They are well suited to less liquid asset classes such as loans, infrastructure debt and commercial property where it is not as possible to hold those assets in an open-ended fund.”

Mr White describes investment trusts as “liquidity enhancers” for some asset classes. “I would not deny it is an issue, but for the less liquid sectors, they can improve rather than detract,” he adds.

“There is a wide range of liquidity and marketability available in terms of investment trusts, but I think for most individual investors liquidity should not be a problem.”

Nothing becomes something

The problem with liquidity arises when an adviser wants to allocate one particular investment trust to all his clients at one point. For some smaller trusts, the market size is not sufficient and it may require multiple deals over a few days. Mr White says this is not attractive to investors in comparison to being able to allocate all their assets in one go to an open-ended fund.

Simon Cordery, head of investor relations and business development for investment trusts at F&C, says liquidity can be an issue if an order to buy or sell is too big for the market or when there is the perception that it is too big.

“For the average investor who is directing their own investments on a day-to-day basis, it is not going to be an issue. However, if you are a large conglomeration of discretionary fund managers (DFMs) who want to put on a multi-million pound trade, it can become a problem,” he says.

“A lot of people will say liquidity is not an issue but it has to be taken into consideration,” Mr Cordery adds, saying that it is often far easier to make an investment than to realise an investment.

“Liquidity is certainly something that any potential investor in investment trusts must do research into. Investors need to find out how well it trades, but investing on a small basis should not be a problem,” he adds.

Mr de Sausmarez says liquidity is only an issue for the regular investor depending on how the broker or share-dealing service handles the vehicles. If they bulk-deal, it may be a problem as it is a larger amount of money and there may not be a guarantee of execution of that service.

Liquidity versus performance

Table 1 illustrates investment trust liquidity based on value traded over five years to 1 March according to Morningstar data. Looking at liquidity versus performance, there is no obvious correlation. For example, the most liquid offering, from 3i Group, shows total value traded to be £11.1bn against a loss of 16.1 per cent pa. Conversely, the third most liquid trust, Mark Mobius’s Templeton Emerging Markets investment trust, which has traded a total value of £3.1bn over five years, returned 9.3 per cent pa.

There was a stellar performance, however, from the Murray International Trust. Managed by Bruce Stout at Aberdeen Asset Management, the trust returned 13.6 per cent pa, the 30th best performing closed-ended vehicle over five years.

Table 2 shows liquidity for the top-performing investment trusts over five years to 1 March. What is immediately obvious is that there were much smaller amounts being traded. The average return for all investment trusts over five years is 3.4 per cent pa.

However the findings in the Table show the top performer, Biotech Growth – managed by Frostrow Capital – returned 27.3 per cent pa over five years, a £3,346 return based on an initial £1,000 investment. Total value traded for the trust was £90.3m during the five-year period, less than 1 per cent of the value traded by the 3i trust. The seventh best performer, Worldwide Healthcare, has traded £323.4m over five years and returned 18.1 per cent pa. The Polar Capital Technology trust traded almost double that at £633.7m and was the 18th top performer, returning 14.9 per cent pa.

Post-RDR

Investment trust managers had been anticipating a boost in interest after RDR regulations banned commission fees on product sales at the start of the year, but has this been borne out?

“We haven’t noticed any increased buying, but we have seen an increase in general interest,” says Mr de Sausmarez. “There are now a lot of IFAs who are starting to look at them.”

Thus far investors have not bought as many trusts, as the issue remains that they are not on platforms. Mr de Sausmarez says he is seeing a slow increase in interest but investment trusts will eventually get a bigger slice of the market. He says it will just be a slow burn.

Mr Cordery says while he has not seen a huge wave of interest, it does not mean there is no additional interest. He says some IFAs may have outsourced to a DFM after RDR implementation, but they may have already been buying investment trusts originally.

While there has been no sudden explosion of investment trust purchasing, interest is increasing. However, the perception of liquidity issues continues to trouble the space. What is clear is that while liquidity may not be an issue for the average investor, it may have a longer-term effect on the return and so should not be overlooked. As Mr Cordery says, “Liquidity is potentially an overblown issue used as an excuse not to use investment trusts.”