Russell Taylor on 150 years of investment trusts

This regular savings policy, invested by the life company in a well-diversified portfolio of property, bonds and shares, and designed to pay a regular income to the family on retirement or death, ceased to be necessary as company pension funds proliferated.

Market changes and lost knowledge

The endowment policy was not very transparent. Based on individual company estimates of life expectancy, investment returns, and potential profit and loss, surrender values of endowment policies could be mystifyingly low. 

The units of third-party unit trusts seemed refreshingly simple by comparison, and pleasingly profitable. Unit trusts were soon the new investment rage, and the investment trust withered.

Many investment trusts disappeared as their advantages – the ability to invest in foreign markets, and to hold foreign currency – became attractive to other companies that were limited in their growth plans by post-war foreign currency rules. 

These businesses bought investment trusts by share exchange, thereby acquiring their easily realisable assets at significant discounts, as a cheap rights issue and a way around Treasury restrictions.

But investment trusts had not been erased entirely by the time political changes destroyed the ubiquity of company pension plans. Later, disappointment in the investment performance of private pensions and unit trust savings plans showed the transparency of their pricing structures was not all it seemed. 

Investment companies began a slow return to popularity, especially those dedicated to illiquid investments such as infrastructure projects with government guarantees under private finance initiative rules.

Forgetting first principles and operating systems

During the 1990s, investment company boards lost their heads: desperate to replicate the sales success of their unit trust competitors, they forgot the importance of compounded income. 

Financial engineering seemed the answer: split shares into different categories of high guaranteed income, rising income and capital value on redemption, and offer investors a choice.

But the next bear market destroyed the faith placed in investment trusts. Losses amounted to more than £600m with over 40 trusts bankrupted. It is rare that real life offers genuine experiments; this scandal directly proved that investment is about income and capital, and that they cannot be separated.

Those trusts that remembered their operating principles survived and prospered. The average equity income trust has increased its dividend by 4.5 per cent a year over the past 20 years. An investment of £100,000 would have produced a similar income over the years, while the capital value today would be £350,000. Another lesson: compounding income requires time and patience.

But investment success is more than a selection of individual companies. It is a choice of an unknown future made through a portfolio. This can be bottom-up – the selection of shares – or top-down: a selection of asset classes and of geography. The latter is best: strategy before tactics.