Breaking new ground: Why the investment trust is offering unique – and growing – opportunities

Investment trusts have undergone something of a celebritisation
Investment trusts have been around since the 1860s, but a perception of obscurity and limited choice has meant that they have not been as well-regarded as their open-ended counterparts. In recent years, however, their popularity has been on the up. Indeed, in 2014, investment trust assets hit a record high of £122bn, with purchases by advisers via platforms more than doubling since 2012, according to the Association of Investment Companies (AIC). The Retail Distribution Review (RDR) in 2012 changed charging structures, giving advisers more of an incentive to research and recommend investment trusts, as the former now charge an overall advice fee rather than receive commission.
And investment trusts have also undergone something of a celebritisation. In the last five years, their popularity has grown among a wider group of investors attracted by “bigname portfolio managers and a healthy level of new launches,” explains Nicky McCabe, head of investment trusts at Fidelity Worldwide Investment. Back in 2010, Fidelity’s China Special Situations trust was launched, with Anthony Bolton at the helm. And this year, Neil Woodford launched the Woodford Patient Capital trust.


As closed-ended funds, investment trusts issue a fixed number of shares. They’re also publicly listed companies, with a board and shares traded on an exchange. Because they are listed, investors can buy and sell from the market, rather than having to deal with a fund management firm. The price of shares is determined by supply and demand. So factoring in market sentiment, the abilities of the board and the management of the trust, the price can differ from the underlying value of the trust – the net asset value. If a trust trades above this, it’s trading at a premium. Below, and it’s a discount. While narrowing discounts reward existing shareholders, widening ones can mean access to diverse and developing markets at below the value of the underlying assets.
Like unit trusts (which are open-ended), investment trusts give the ability to pool resources and maximise economies of scale, while also allowing greater diversification of assets to manage risk and enhance returns. But their make-up also offers investors some specific advantages.
For starters, having an independent board means that investment trusts have a strong level of independent oversight – and an annual general meeting to discuss the direction of the company with shareholders means there is more engagement for investors. Additionally, they have the ability to borrow money to invest, meaning that they can leverage their exposure, known as gearing. The outcome of gearing is highly contingent on the manager and value of the market at a given time, says Adrian Lowcock, head of investing at Axa Wealth.
They are also a consistent option for investors. The fact they are close-ended means managers are looking after a fixed pool of assets, so they can concentrate more on medium to long-term income. And when necessary, says Simon White, head of investment trusts at BlackRock, “they can smooth the dividend pay-outs, either by using revenue reserves or the facility to pay out capital profits” – investment trusts are allowed to hold back up to 15 per cent of their dividend earnings each year. This sustainability of income can make them an alternative income option in this low-interest environment, adds White – particularly when considering pension options.
Trading a fixed number of shares means that managers don’t have to deal with daily inflows and outflows of capital. “They are not forced to buy and sell stocks each day, reducing overall dealing costs and allowing the manager complete flexibility on when they wish to trade,” explains McCabe.


The flexibility investment trusts provide means that the range of asset classes and investment areas they offer access to is vast. “Each manager is an expert in that region or asset type, so through constant hands-on contact with these companies, they can find some potentially unusual sources of income,” says White. Investors could go for anything from UK small companies to Brazilian construction, to oil in Turkmenistan – areas that are not readily available through other means, he adds.
Fixed capital means that investment trusts can excel in more illiquid sectors and asset classes, and historically they have offered outperformance in alternative asset classes including debt, infrastructure, property, frontier markets and biotech. The latter, along with healthcare, has produced “particularly strong returns”, according to the AIC, and is the top-performing investment trust sector over one, three, five and 10 years.
Gearing and narrowing discounts contribute heavily to the ability of investment trusts to do better than open-ended funds in rising markets. Despite a bumpy ride for emerging market equities over the past year, Fidelity China Special Situations, which has had Dale Nicholls at the helm for the past year and has a market cap of £977m, has returned 71 per cent – compared to 30 per cent for the average trust in the sector over the period.
It was able to invest in Alibaba pre-IPO, demonstrating how investment trusts can access smaller companies, real property or unlisted firms. The Alibaba investment, says McCabe, “has been a contributor to the strong performance of the trust over the last year”.



When it comes to popularity, investment trusts still have “some way to go”, says Darius McDermott of Chelsea Financial Services – two stumbling blocks remain. First, not all platforms offer access to investment trusts. “They say this is because there is still not the demand to warrant it, but it’s a bit of a chicken and egg situation,” says McDermott. And second, since RDR, costs are on a more level playing field with open-ended funds, which means they no longer look as cheap, with many charging performance fees as well as annual charges. A 2014 FE poll found that more than 70 per cent of advisers and investors think investment trusts are cheaper on the whole, but that’s often because of lower headline charges, which lead many to assume that they are better value.
As is often the case, the devil is in the detail. “When comparing the cost of investment trusts, it’s important to look at the total cost of ownership, known as the OCF,” explains McCabe. Because investment trusts deal less frequently, fixed additional costs tend to be reduced, she adds. So even if the annual management fee is more than the cheapest openended investment company (OEIC) share classes, “the total cost of ownership is often comparable, and may be lower,” she explains.
Similarly, less dealing, combined with the use of gearing in investment trusts, means that they frequently outperform OEICs over longer periods, after fees have been deducted, says McCabe. “At the end of the day, investors should focus on value for money, not just cost. Are they getting a strong-performing trust which will deliver, net of fees?”


Last year wasn’t a great year for investment trusts. Gearing and widening discounts worked against a number of them – on the back of concerns over valuations, rising interest rates and the end of QE in the US – and this prompted worries of a re-rating.
But the hiccup was relative, and average discounts have narrowed over the last five years, as demand for “equities in general, and investment trusts in particular, has increased,” says Nicky McCabe of Fidelity Worldwide Investment. Between 2009 and 2013, the average trust in the Global Equity Income, UK All Companies and UK Smaller Companies sectors beat their open-ended counterparts every year except for 2011. UK Equity Income outperformed over all five.
Even so, most trusts are still trading at a discount, offering investors opportunities to invest in well-performing trusts at good value. Adrian Lowcock, head of investing at Axa Wealth, suggests the Witan Investment Trust. The equitybased trust has been going for 100 years, and is currently trading close to net asset value. It invests globally for long-term growth, with a history of strong performance. In 2014, dividends rose 6.5 per cent – the fortieth successive rise. Always make sure you consider why a trust is trading at a discount, though, warns Lowcock – “a discount can be a great way to buy a cheap market cheaper, but it’s important that you do your research first.” It may be down to market sentiment or taking into account the cost of winding up a fund, but it could also be because of a poor view of the management team.
However, Lowcock prefers unit trusts to investment trusts in the current climate – because the latter tend to do better when there has been a sell-off. “At present, with markets fully valued, we would need to see further earnings growth to see the next leg up for investment trusts”. That said, surprise growth would see the gearing of investment trusts come into its own and provide a boost, he adds.