In the post-RDR world, the need to offer advice across the whole range of retail investment products has challenged some advisers.
So, what should you consider when looking at investment trusts?
As with open-ended funds, an adviser should look at the quality of the fund manager, the team, the investment process and business. Other factors include:
• Gearing: While the level of gearing itself is important, the adviser should also consider the method used. Some trusts may have locked themselves into high interest rates with long-term gearing instruments; others have shorter-term facilities in place.
• Discount: The adviser should not only consider the level of the discount, but how it compares to its historical level (the Z-statistic). Trusts have a greater tendency to revert back to a mean level of discount than to par value.
• The discount control mechanism: Both the policy in place and the means of enforcing it need to be considered. A board may have a target level of discount, or a vague promise to keep the discount at a reasonable level. In practice, it may be difficult for a smaller trust with less liquid assets to maintain a target level of discount.
• Liquidity: The assets under management of the trust is important, but could give a misleading picture when some shares are not available for trading. To counter this, the adviser should also check the real-world bid-offer spread of the trust to gauge its level of liquidity.
• Structure: Advisers should be wary of trusts with complex share capital structures. However, approximately 95 per cent of trusts do not fall into this category.
• Manager access: In some cases, the adviser may want access to an open-ended fund that is currently closed. In this instance, an equivalent investment trust run by the same manager could provide a workaround.
• Fees: Fees in the investment trust universe are more complex than open-ended funds. Performance fees are still common and the adviser needs to consider any hurdle rates and maximum caps imposed on such fees.
• Use of derivatives: The closed-end nature of a trust makes it ideal for gaining exposure to less liquid instruments, such as options or contracts for difference (CFDs). The investment trust manager may decide to hold such instruments. The adviser should be aware of this and ensure they understand how the manager is investing.
• Dividend policy: Some trusts pay generous levels of income relative to their open-ended cousins. Some managers generate fee income by writing covered calls against existing assets, the downside being lower capital growth in the trust.
• Platform access: Investment trusts are not available on the three biggest platforms, but are available on others. As interest grows, we expect access to improve.
As with all these things, the devil is in the detail, so quality research is key when making recommendations to clients.
Chris Riley is investment research manager at Rayner Spencer Mills Research
INVESTMENT TRUSTS: KEY TERMS
Net asset value (NAV)
The value of the investment company’s assets, less any liabilities it has, divided by the number of shares
Discount
The percentage by which the share price is less than the NAV per share
Gearing
At its simplest, borrowing money to buy more assets in the hope the company can pay back the debt and interest and leave something extra for shareholders
Premium
The percentage by which the share price is higher than the NAV per share
Source: AIC glossary
