Decisions, decisions for savers

My reply was that you will pay a fee for owning Mastertrust, plus additional dealing fees as the managers attempt to show how clever they are by buying and selling their underlying investment trust holdings. I also added that the only proved certainty of investment success was to keep fees low and the investment process simple.

Mastertrust shows ignorance – shared by many investors and IFAs – of what an investment trust is. It is a mutually owned investment fund, but is not a unit trust, nor an exchange-traded commodity (ETC). Instead it is a legally constituted company quoted on the London stock exchange that, instead of making widgets or selling services, invests its capital [money] in quoted securities.

Thus the portfolio is limited in size, and is an end in itself. It is designed to achieve the investment purposes determined by the Board of Directors, given their views of political, economic and market risks, and tactically executed by a selected investment manager. This has proved itself to be a robust structure; several investment trusts are over a century old, with many more recently formed to take advantage of new business opportunities such as infrastructure investment.

Investment trust performance

Table 1 shows the investment performance of three investment trusts, all with differing purposes, but all classified as global in their investment opportunities. The Table starts in 2000, the year following the bursting of the TMT bubble, continues to 2008 and the government rescue of the banking system, and ends in March this year. These were all signals, for those who wished to see, that the investment world was changing.

The Table is based on Nav (net asset values) so avoiding the ups and downs of share prices compared to Navs, and thus concentrating solely on investment performance. This after all is the purpose of an investment trust, and the justification of its investment fees. And though the differences in percentage growth terms may seem slight, the change in NAV per share easily shows how important those minor differences really are.

Scottish Mortgage shares have more than doubled over the period, Personal Assets has seen its price rise by something less than twice but the Alliance NAV has not even increased by 50 per cent.

And investment judgment is about to get more important. Experience has shown that one-year forecasts, whether from central banks or brokers, are generally useless but Jeremy Grantham and GMO over the years since 1977 have proved accurate with their seven year forecasts of asset returns. Their current forecasts are mostly negative, whether for shares or bonds, although what they describe as ‘high quality’ US equities might make an annual return of 0.7 per cent. These are not surprising expectations when large numbers of first world governments expect us to pay for lending our money to them.

These were all signs, for those who wished to see, that the investment world was changing

Why the performance differences?

Every company has an internal cost of capital or, put another way, a hurdle rate against which new investments must be assessed. Directors who forget this sooner or later run into trouble, as Tesco shareholders recently discovered. For investment trust companies, the internal cost of capital is low, as they run very simple businesses, but then the returns that they can make are also low.

All would-be investment trust buyers need the AIC and Numis Securities websites, both of which are free. The key documents are the reports of the directors and the fund manager. Do they correspond with each other, not just over one year, but over time, and does each support the other?

Scottish Mortgage is a good example. The purpose of the company is to make money for its investors by identifying the new technologies that are transforming both life and business, and riding this wave over the next five to 10 years. To this end, the managers have broken down these developments into much more detailed industrial sections than those encompassed by index classifications; additionally having built their positions in these emerging companies, and the share prices also having prospered, the managers are reluctant to reduce them for the purpose of ‘balance’.

As a result, some traditional analysts are uncomfortable with such a concentrated portfolio, and indeed the Numis volatility graph shows Scottish Mortgage to be at an extreme range. At the other end is Personal Assets, and these two trusts are a good pair to match, since Personal Assets is a good hedge if, and when, markets collapse.

Other ways to skin a cat

The investment purpose of Personal Assets – is and in this order – first to protect its investors’ capital and only secondly to increase it. Currently, believing all markets to be over-valued, the managers are only 40 per cent invested with the rest of the capital in cash, index-linked bonds and gold.

This policy enabled Ian Rushbrook of Personal Assets to outperform in the period to 2008. Rushbrook knew when to do nothing, because nothing should be done, but he was also a skilled poker-player, using the FTSE100 index to gear and de-gear the portfolio, while also adding dealing profits to the dividend stream. Rushbrook’s untimely death forced Personal Assets to outsource its management to someone equally cautious but, sadly, lacking his gambling skills.

Alliance Trust is one of the stars of AIC’s dividend heroes, having increased its dividend for each of the last 48 years. A desire to protect the income of its many small and loyal shareholders is certainly one of the investment objectives of the Board and, although there is nothing special about the investment objectives of the managers, they have produced reasonable returns over the period.

Can the dividend increases continue?

The problem is the Board itself for, unlike the other two, Alliance is not run as an investment trust with tough controls on costs, but seems to wish to be a financial services company. Rather than concentrating on building up its shareholder base, the Board runs two major subsidiary companies – one a would-be ‘platform’ company and the other a third party investment manager.

Neither of these is profitable, nor show signs of becoming so, and the Board has lost sight of its most important task – like Tesco, they are spending capital regardless of its internal cost. This is the reason that over recent years various disgruntled shareholders have attempted to unseat the present Board.

Whether Elliot has succeeded in its attempted boardroom coup will be known by the time that this is printed but if they fail – likely on past history – shareholders should take the opportunity to switch to a more shareholder-friendly trust.