With a history that goes back over 140 years, the investment trust sector has seen it all, but what does the future hold?
In the 15 years since the launch of Investment Week there has been an awful lot of water under the bridge of investment. From the steady market rises of the mid to late 1990s to the ‘irrational exuberance’ of the tech boom and subsequent bust; from the wilderness years of the early 2000s to the ‘Baghdad bounce’ of 2003; and from credit feast to credit famine, investors have had many occasions to ponder the warning “the value of investments can go down as well as up”.
At the product level too, we have seen many developments. Unit trusts have largely given way to OEICs, and the open-ended fund universe has also had to contend with successive UCITS directives aimed at levelling the playing field for fund distribution across Europe.
So what of the humble investment trust in this pan-global, electronically settled world? Well, in spite of their (frankly undeserved) reputation as being somewhat old-fashioned, time has not stood still for these founding fathers of the retail investment industry. Even some of the largest and oldest trusts, such as Foreign & Colonial Investment Trust and Witan, have embraced modern concepts like outsourcing and multi-manager. And with the Retail Distribution Review promising to remove commission bias from the sale of investment funds, investment trusts will be as worthy a choice as ever in the years to come, and perhaps even more so.
Open or closed?
A glance at the performance graph below will show that there has been little to choose in performance terms between equivalent open-ended and closed-ended funds. Investors in F&C’s own US Smaller Companies funds have been broadly similarly rewarded over the past 15 years, while those in Fidelity’s Special Values investment trust have done rather better than investors in the stellar-performing Special Situations fund. Over different time periods one structure might perform better than the other, even though the investment trust and the OEIC have the same manager and broadly the same portfolios.
So why choose an investment trust over an OEIC? Well, for one thing the ‘what you see is what you get’, single-priced transparency of an OEIC can be rather muddied by the effects of commission and upfront fees. That isn’t to say there are no fees involved in buying investment trust shares, but the flat fees for dealing imposed by most stockbrokers are a little easier to quantify. The investment trust also has a few unique features that can work in investors’ favour over time.
The first of these hinges on the ‘closed-ended’ nature of the investment trust. Share prices are dictated by supply and demand, and will lag the net asset value of the trust (trade at a discount) if there are more sellers than buyers. To meet a wave of redemption requests, open-ended funds will often have to dispose of liquid positions they would rather not exit if they had the choice – selling the family silver, if you like. Investment trust managers can take a longer-term view with their investments as they do not have to sell holdings to meet redemptions.
Of course this can be less than ideal for the investor wishing to exit, who may have to accept less than the underlying asset value of his shares. But for the canny buyer, the ability to pick up shares at a discount can mean an extra boost for his investment when sentiment improves and the share price and net asset value converge. This may take a while, which is why investment trusts (like other equity-based investments) are best viewed as a longer-term investment choice.
Gearing up
The ability to gear, or borrow money to invest, is another two-edged sword that works best over longer periods. In a falling market, a geared investment will take a proportionately bigger hit than an ungeared investment, as the net asset value falls but the value of the debt remains constant. But in a rising market, the geared investment does proportionately better, as the outstanding borrowing becomes a smaller part of the overall asset value. If you believe equity markets will rise over time – which, after all, is why we are all in this business – then the upsides of gearing (as long as the borrowing is at a favourable rate of interest) should outweigh the downsides.
Governance
The financial crisis of the last couple of years has turned the spotlight on to corporate governance, and here again investment trusts have an advantage. As listed companies, each investment trust has its own independent board, whose duty it is to act in the interests of shareholders. The manager of the trust must act within the parameters set out by the board, so the kind of undue risk-taking that fomented the crisis should be less likely to occur. Because the board must keep shareholders’ interests at the forefront, investment trusts are also arguably less likely to fall prey to fads and fashions, where investment houses might rush out a fund in a ‘hot’ sector but divert resources elsewhere when the trend goes off the boil.
But while they may be less prone to changing fashions, investment trusts are also a good way to access less liquid areas such as commercial property and private equity, where again the closed-ended structure allows a longer-term view to be adopted.
Opportunities and threats
Looking to the future, the biggest opportunity for investment trusts is probably regulation-driven, in the form of the Retail Distribution Review. Wealth managers at the top end of the advisory market have been enthusiastic supporters of trusts for many years, and the increasing levels of professionalism the RDR seeks to embed into the wider market will – we hope – lead to more diverse portfolios for the end investor, encompassing a range of vehicles chosen for their investment merits alone.
However, regulation also poses the greatest threat to the 142-year-old investment trust sector. European moves to tighten up controls on ‘alternative investment funds’ have caught investment trusts within their scope – something the industry feels is probably an unintended consequence, as the investment trust sector is a peculiarly British one, for which few if any EU member states have anything comparable. The Association of Investment Companies continues to lobby the British and EU governments on this issue, and early indications are that its voice is being heard.
The picture on the Alternative Investment Fund Managers (AIFM) Directive will become clearer later this year. But as we raise a glass to Investment Week’s 15th birthday, we hope we can also toast the continued health of the investment trust sector, which has served its investors well for more than 140 years, yet remains as relevant today as it has ever been.
Mike Woodward, head of investment trusts at F&C Investments
