Discounted assets with a strong record

Investment trusts have big advantages but they can not do all the hard work

IT’S WIDELY believed that actively-managed funds are overpriced. Research from Lipper recently found that just 38 per cent of actively-managed UK equity funds outperformed their benchmark over 10 years. When you consider that active funds charge investors more than their passive equivalents (which simply track their benchmark), they quickly look to be bad value.

But dig deeper, and active funds aren’t quite the poor cousin they might appear. Investment trusts, which tend to be actively-managed, have outperformed the market in seven out of the last 10 years, according to data from Winterflood Securities. And they look set to do well again in 2013.

Investment trusts are also relatively underused in portfolios. Financial advisers were once reticent to promote them to clients, as most did not come with trail commissions. But a potential for outperformance, and other unique advantages, should coincide to make investment trusts a more popular vehicle for investors in 2013.


Unlike open-ended investment companies (OEICs), investment trusts are closed-ended investment firms, which issue a fixed amount of shares that can be bought or sold on an exchange. They are subject to brokerage fees (usually between £10 and £15 per transaction), and charge annual management fees based on a percentage of assets under management (AUM). They can be held within an Isa or self-invested personal pensions (Sipp), allowing you to shelter gains from tax as long as the trust is listed in the UK.

Investment trusts have a remit to invest in specific assets or sectors. For example, 3i focuses on mid-market private equity. And last month the Greencoat UK Wind Investment Trust raised £260m to invest in wind farms. Jackie Beard of Morningstar says “these sorts of investments are unlikely to work as open-ended structures. They are investments in actual businesses, rather than just buying shares, and they require a certain closed-end capital base to do that.” But this doesn’t mean that investment trusts can’t invest in shares. The Fidelity China Special Situations investment trust, for instance, specifically looks at Chinese companies that are undervalued, or have good potential for recovery.


Last year, Winterflood Securities data showed that, while the FTSE All-Share index rose by 12.3 per cent, the UK investment trust sector notched up 14.8 per cent growth. And that trend seems to be continuing into 2013. Investment trusts have outperformed the market by over 1 per cent so far this year.

One reason for the edge may be because managers do not have to contend with sharp fund inflows and outflows, which could impact on investment strategy. This is particularly useful in less liquid sectors, like emerging markets. And unlike OEICs and unit trusts, investment trusts do not have the same borrowing restrictions. They can gear – or borrow money – to amplify returns. Simon Elliott of Winterflood Securities warns, however, that this is a double-edged sword: “When markets are strong, gearing has a positive impact. Conversely, in falling markets, the reverse tends to be true.”


Further, the price of an investment trust is not derived from its inherent net asset value (NAV). Trusts are priced according to supply and demand, and can trade at a discount or a premium. The average UK investment trust is now trading at a 6.4 per cent discount to NAV. This has been steadily narrowing since the middle of last year, which Elliott argues reflects “strong market conditions that have resulted in a pick-up in demand for riskier asset classes.”

There are several theories explaining this discount. One is that it depends on market sentiment towards the asset classes that an investment trust invests in. But Beard cautions against buying specific trusts based on their discounts alone. “We believe in long-term investing, so the discount shouldn’t be an overwhelming part of an investment decision,” she says. “However, discounts can give you an opportunity to buy at a cheaper price.”

But it’s important to monitor the costs of the investment relative to the track record of the fund manager. Five firms have encouragingly slashed their charges in recent months, including Fidelity and its China Special Situations trust, Edinburgh Worldwide, and four trusts from Baillie Gifford.


While investment trusts have unique advantages over other investment vehicles, they are still just a vehicle. And Beard says that “the vehicle itself should not drive your investment decision – the strategy should”.

She suggests a potential approach: decide what you want your portfolio to do, and then find suitable investment vehicles that can achieve those goals. She cites the example of emerging markets equities. Once you have decided you want exposure to this sector, you can consider investment trusts alongside open-ended investments, as well as exchange-traded funds. All of them can work towards reaching your goal.

One strategy is for your portfolio to have a core of passive investments, and then use vehicles like investment trusts, and other actively-managed investments, to add “alpha” to your portfolio (a risk weighted measure of outperformance).

Your own strategy is, therefore, just as important. Only by taking the active approach yourself will you find the right trust that fits your portfolio.