For investment trusts, 2009 has not been without its excitement. Volatile discounts have made life very difficult; the flight to quality was swiftly followed by the dash to trash as investors switched to more exotic investments
It is difficult to find a word to describe what an emotional roller coaster 2009 has been. From the depths of despair in March to the dizzy heights of mid November, the FTSE All Share has bounced by 52%, and is on course to produce its best calendar year return since 1993.
To what extent this recovery has been induced by QE will only become clear when the tap is turned off. For investment trusts, 2009 has not been without its excitement. Volatile discounts have made life very difficult for trusts; the so called flight to quality in Q1 was swiftly followed by the dash to trash in Q2 as investors switched to more exotic investments. This changeable demand resulted in a number of the bigger global growth trusts trading at significantly reduced discounts, and in some cases at premiums, only to then see their discounts widen despite the market rally.
The liquidity crisis did however help quash arbitrage activity, in the short term at least. Borrowing became increasingly difficult and expensive to secure, and the increased cost of derivatives meant that after Mr Arbitrageur had hedged out his position there was very little margin left.
This year has equally been a year of opportunity for investment trusts. The ability to gear means that in a rising market investment trusts can magnify their exposure to the market, but by the same token in a falling market gearing magnifies losses. It must have come as quite a shock to investors of certain investment trusts when their annual statement arrived at the beginning of April and they saw that the value of their investment had halved over the previous six months.
As a result of the market volatility, many trusts reduced their gearing. Some braver souls stuck with it and as a result were repaid when the markets rallied.
However it was the investment trusts that deployed their gearing at near to the bottom of the market that were really rewarded and it is thanks to these trusts that over the past 12 months the average investment trust has outperformed the average unit trust by 4.6%.
Investor perceptions and appetite for investment has been slightly surprising given the market conditions.
According to figures published by the IMA the 2009 Isa season saw net inflows that were 74% higher than for the 2008 Isa season. And thanks to the increase in the Isa limits, October recorded the highest number of Isa sales outside the Isa season since June 2000.
As 2012 and the onset of RDR approaches, more and more is being written about the affects the review will have on the financial services industry. By hook or by crook the FSA is enforcing greater transparency and clarity on the industry – investors need to understand what they are investing in, the associated risks, and exactly how much they are paying. For these reasons RDR could well cause a renaissance for investment trusts as they already tick many of the boxes: investment trusts are on the whole considerably cheaper than unit trusts; the role of the board of an investment trust ensures impartiality and accountability to its shareholders; being a publicly listed company means that there is a greater emphasis on corporate governance and transparency.
In the shorter term 2010 promises to be a challenging year for the investment trust sector. The Alternative Investment Fund Managers Directive (AIFMD) threatens the entire investment trust industry. Drafted as a direct result of the financial crisis, in particular the collapse of Lehman and the Madoff scandal, the AIFMD aims to create a comprehensive supervisory and regulatory framework for alternative investments. Unfortunately the definition of alternative investments also currently includes investment trusts.
Many of the new rules are either not appropriate for investment trusts or are simply not needed. For example the directive requires investment companies to offer redemption of its units. As all investment trusts can be bought and sold on the London Stock Exchange this falls into the not needed category. The draft directive also threatens to prevent the appointment of managers outside of the UK. As a multi-manager investing on a global equity mandate, this could cause problems for Witan. The AIC and the rest of the investment trust industry are currently lobbying for change before the target transposition date of 2011.
Closer to home, the outlook for the UK is impossible to call, through using quantitative easing we are sailing in uncharted waters. Although economic data is improving and investor sentiment has strengthened, much uncertainty exists. The economic recovery faces a number of big challenges including rising unemployment, weaker consumer spending and stretched government finances.
Despite this mixed outlook we expect demand for investment trusts to continue to be strong. The Isa season promises to be the best for many years as a result of the increased subscription limits, and the prospect of RDR means that for the first time in many years investment advisers are warming to the idea of investment trusts. Bring it on.
James Frost, marketing director of Witan Investment Trust
