Investment Income CPD Course  

An exploration of investment trusts and client suitability

  • Explain why investment trusts may be suitable for certain clients.
  • Describe key elements of investment trusts and how they work.
  • Understand how they can be used effectively to augment certain client portfolios.

If your client relies on income from their investments to fund retirement, reliable dividend payers such as dividend heroes could be eminently suitable. Modest levels of gearing (City of London has 8 per cent) can further boost the income available.

The caveat is that clients must be able to accept some volatility in the capital returns of their investment. To continue with City of London as our example, its share price (ignoring dividends) was down 16 per cent in the 2020 calendar year as the UK stock market was hit by the pandemic. 

However, to come back to client suitability yet again, if the client perceives risk as a fall in their income, as opposed to the volatility of their capital returns, then that might well lead you towards investment trusts.

While dividend increases are never guaranteed, the pandemic experience was encouraging for those who had put their faith in investment trusts’ revenue reserves. 

In 2020, 85 per cent of income-paying investment trusts that invest in equities held or increased their dividends, compared to just 24 per cent of equivalent open-ended funds.

In the UK Equity Income sector, 91 per cent of investment trusts increased dividends versus 4 per cent of open-ended funds.

A decision to use investment trusts as part of a natural income strategy can easily be justified, provided that the client can accept some risk to capital. 

Performance advantage

The evidence that investment trusts outperform equivalent open-ended funds is strong. 

Comparisons of investment trusts with open-ended sister funds run by the same fund managers show that the investment trusts outperform in the majority of cases over five and 10 years.

This is not surprising when you consider that investment trusts have the advantage of the closed-ended structure, which gives managers the freedom to buy and sell investments when they want to, rather than have their hand forced by flows.

Gearing is also a factor, though less significant than you might think, given that about half of investment trusts have no gearing and the average gearing across all investment trusts is just 8 per cent – £8 borrowed for every £100 of net assets.

Investment trusts sometimes – not always – have lower ongoing costs than open-ended funds as well. 

Being able to look across the open-ended and closed-ended funds universe makes an adviser more likely to pick a product that is suitable for a client, with the right balance of risk, performance potential and cost. 

But more specifically, the performance advantages of investment trusts may make them particularly suitable for investors with long-term goals and objectives; those saving for children, for example, or clients with plenty of years ahead of them. 

The question of risk

Of course, a client’s risk tolerance needs to be taken into account. All investment trusts are equities, quoted on the stock market, whatever their underlying assets.