While interest rates remain at their lowest level and hunger for higher yields keeps increasing, newly liberated retirees find themselves hunting for ways in which they could invest their pension pot.
A range of income-paying unit trusts has been launched since the pension freedoms came into effect in April this year. A number of retirees have also been investing their money in the real estate market and other alternative investments in order to diversify their portfolio away from the traditional drawdown or annuities. But while the options are vast, investment trusts are one vehicle that, although considered expensive and risky, could be ideal to provide the required returns.
Financial advisers suggest clients construct a ‘well-balanced’ portfolio when taking control of their pension pots. This means a portfolio in line with their post-retirement risk profile and flexible enough to be able to adapt as and when that risk profile changes. A number of advisers encourage clients to include investment trusts for this very reason.
“The way in which I use investment trusts is to get additional returns for clients, because if you look at any Money Management table over 10 years, investment trusts always outperform unit trusts,” says Ray Best, an independent financial adviser at Berkshire-based Una Vida Life Planning. “Very rarely do investment trusts underperform unit trusts over a 10-year period. These are average figures, and if you take a good investment trust, it will perform far better than the average.”
Data from Morningstar supports this, showing investment trusts’ outperformance over every timescale.
Meanwhile, the Chart shows the total assets under investment trusts from 1980 onwards. They are clearly, but steadily, growing in popularity.
Unique advantages
Many advisers point out that investment trusts have several advantages over open-ended funds. Apart from paying dividends out of the income they receive from investments, these companies can also pay dividends out of the profits they make when they buy and sell investments. This is income valuable for investors in retirement.
Unlike other types of funds, investment trusts are entitled to keep back up to 15 per cent of the income they earn each year for their reserves. This gives them a buffer from which income payments to investors can be made in years when the fund’s earnings disappoint. Advisers say this is something that could appeal to retired investors who need a consistent income especially as they plan to live off the income generated by their life’s savings.
Furthermore, according to the Association of Investment Companies (AIC), investment trusts can be a useful part of a Sipp portfolio due to the advantages of the structure: good long-term performance due to gearing, their closed-ended structure, from an income perspective they have a good deal of flexibility, and – with shareholder approval – they can pay income out of capital.
But many will still stay away largely because of their being labelled as ‘risky’.
“Investment trusts are always looked at as being high-risk, but if you have a large discount in investment trusts, in particular if it is trading at the end of its range that is towards the largest discount rate on average, then I don’t view them as high-risk,” says Mr Best. “I view them as actually relatively low-risk. But they could potentially produce additional returns.”
Some advisers also point out that investment trust companies, unlike managers of open-ended investments do not need to buy and sell holdings to accommodate the expansions and contractions in fund size which result from investors buying into or selling out of the fund.
The number of investment trusts paying dividends over extended periods highlights their potential to investors looking for a growing retirement income. Many investment trusts have increased their dividends in each of the past 25 years.
And while investment funds can be more risky in the short-term, they often outperform in the long-term. According to the AIC’s Pensions Consumer Guide, investment companies’ long-term average is beneficial for pensions, which it calls the longest financial investment an investor will make.
The AIC report also argues that investment companies offer access to a much wider choice of investments due to their closed-ended structure, such as commercial property, infrastructure and renewable energy. These assets can offer a higher level of income and, it claims, are often better suited to being held in a closed-ended fund like an investment company. The trusts can also include investments which, although often more risky, can outperform in the long-term, such as private equity.
Finally, investment companies can borrow money to make additional investments, also known as gearing. Gearing increases risk, but when used effectively can increase profits.
Are they of interest?
While the investment companies offer long-term returns and a viable option for retirees to invest their pension pots, advisers have pointed out that they are still not as popular as they could be.
A commonly held view is that investment trusts have not become very popular chiefly because advisers do not understand them very well. They are not very confident of the processes and therefore do not recommend them to their clients.
Mr Best advocates this view. “I think the clients are losing out because a lot of the advisers don’t have the confidence and knowledge,” he says.
So what can be done to improve the chances of more investment trusts being added to retirement portfolios? “I think if the AIC did more talks about how exciting they can be and the returns they can get for a client, then that would be helpful to most advisers,” Mr Best says, “It would pass that on to the clients.”
However, advisers and wealth managers also warn of the importance of proper due diligence and understanding the market well before rushing to add investment trusts into a portfolio. Investors should carry out proper research, especially if they are planning to invest their entire life savings in this vehicle.
A number of advisers also warn that, while investment trusts are sometimes considered risky in the short-term, they are capable of achieving outperformance in the longer term.
While the hunt for higher yields continues to drive investors’ decisions, investment trusts could prove to be an attractive option, especially for those looking to park their retirement pots.
“It is a value judgement you make as to whether investment trusts are inherently risky,” says Mr Best. “They have the potential to be but you have to make a judgement based on the size of the discount, what it is invested in, where the market is going. It is quite a complex calculation before you actually decide to include investment trusts but almost all my clients have an element of investment trusts, even quite low-risk clients.”
While the sector returns better yields over a longer-term period, it could fit well with an investor’s ongoing plan for a better and more comfortable retirement.
