Investment trusts may have had a rough ride over the past few years, but well-run trusts present sound long-term investment opportunities, says Julie Dent
Investment trust shareholders could be forgiven for being wary of a sector that is still in the throes of an on-going investigation into allegations of collusions and mis-selling in the split capital trust sector. But of course not all investment trusts were involved in the split capital debacle and it is important to recognise that not all trusts have been impacted by the specific problems of high bank debt and cross holdings in similar trusts.
While the entire sector may have suffered on the back of it, well managed trusts are overcoming this hurdle. Indeed, it is well worth differentiating between the choice of more than 350 investment trusts available to UK investors, which vary between diversified global growth trusts to more specialised regional or sectoral trusts. Even in the international arena trusts are fairly diverse by way of asset allocation, level of dividend and gearing.
Formed in 1868, Foreign & Colonial Investment Trust, the first trust to be launched, aimed to give smaller investors the same opportunities to grow their money as the larger capitalists by way of diminishing risk by spreading investments over a large number of stocks. The larger and more well established international generalist trusts continue to reflect this objective, and today they offer investors a broad-based exposure to a diversified portfolio of UK and international stocks.
Frequently recommended by IFAs as core funds, the larger and more diversified of these have lower charges and offer good value to investors.
Certainly, trusts ensure investors have their money professionally managed at a fraction of the cost that it would take to buy individual shares on the stock exchange.
Furthermore, investment trust shares have long had a dedicated band of followers among more financially savvy parents looking to save for their children. This is particularly true of broadly diversified trusts, such as British Assets Trust, which offer a 'one stop' portfolio.
With low annual management fees on the large trusts and discounts in the sector, investment trusts continue to offer a sound platform for long-term investments on behalf of children and can be tax efficient if held in a 'bare trust'.
Investment trusts, in common with the rest of the market, experienced problems with the end of the bull market in 2000. A number of issues arose from here, the first of which is the widening of discounts (the share price as a proportion of the trust's net asset value (NAV). Investment trusts can trade at a price higher than (at a premium to) or lower than (at a discount to) the value of their underlying assets.
The share price of an investment trust does not always reflect the true value of the assets it owns, and it is for this reason that at present many trusts can be found to offer bargains.
Indeed a large discount presents a great buying opportunity for new investors to a trust. Stock market conditions have pushed discounts out to the highest levels seen for some time. The underperformance of stock markets, particularly blue chip stocks, throughout the three-year bear market certainly disillusioned investors.
In addition, the trusts' ability to gear or to borrow extra funds, meant that while trusts performed particularly well in the bull market, the gearing exacerbated difficulties when the market turned. By March 2003 equity markets were cheap in absolute terms as well as relative to bonds.
At that time, expectations on the outlook for the global economy and corporate sector were also depressed. But now that equities are trading at more reasonable levels and expectations are high there are signs that discounts may have recently started to narrow. According to UBS though, in the summer, discounts on the international trust sector approached levels that had not been seen for around 15-20 years, apart from a brief period in early 2000. (See chart below showing the nine-year discount/premium to 30/09/04 for the Global Growth and Income sector).
We are currently in an atypical situation of rising rates and slower growth. Rising rates are typically associated with rising risk aversion and a derating of equity markets. Less cyclical quality growth stocks in more defensive areas of the market tend to outperform at this time. During the first half of 2004, the UK stockmarket has traded in its tightest trading range for 30 years. Not only do we lack clear market trends, but daily moves over 1% are few and far between.
Business models exposed to equity market volatility have suffered. This has manifested itself in generally poor investment banking results and hedge funds that appear to be struggling to generate returns. The reason for such low level volatility this year can be largely attributed to a lack of conviction concerning future economic direction, which has contributed to a narrower dispersion of sector returns.
Indeed, slower growth, rising inflation and tighter monetary policy are likely to pose a more challenging environment for investors in the coming months. Global stockmarkets have discounted a modest slowdown in global growth but investors are likely to remain risk adverse.
On the one hand, we have the negative headwinds of economic growth disappointment and slower earnings growth. On the other, low bond yields make equity valuations look attractive.
On balance we expect global stockmarkets to make only modest progress in the year ahead. Investment trusts have an enviable long-term performance record and have proved resilient to bull and bear runs in their 136 year history.
They are one of the best ways to achieve long-term capital growth and their closed-ended structure is ideal for investing in volatile markets. A sudden market sell-off does not mean that managers are forced to sell their shares to meet redemptions from investors. Investment trusts may have suffered recently, but they are now well placed to enjoy a period of success.
Julie Dent, manager, British Assets Trust at F&C Asset Management
Investment Trust share prices do not always reflect the true value of the underlying assets.
Slower growth, rising inflation and tighter monetary policy should create a more challenging environment for investors.
Investment trusts have proved resilient to bull and bear runs in their 136-year history.