Investment Trusts

Many private investors are happy to put money into funds, particularly if they are fairly new to stock market investing. What this often means is that they purchase OEICs, Unit Trusts or ETFs from their stockbroker or ISA administrator with a particular emphasis on the first two which are often strongly promoted to them by the “platform” they happen to use. And why is that the case? Simply because your broker makes a lot in commission as a result.

But there is an even better alternative which is an investment trust. These are investment companies which are listed on the stock market, some of which have been in existence since the 19th century. They typically offer the following advantages if you are looking for a “collective” investment vehicle:

Advantages of Investment Trusts

1. Lower charges and better performance. They have lower charges, and hence tend to outperform their OEIC or unit trust equivalents. The reason for this is simply because they typically do not spend money on advertising or other promotional activities, which is why many investors are not aware of them. In addition, the company and its board of directors is usually independent of the fund management and administration activities so can negotiate and control the costs. For example Lipper reported in June 2012 that over 18 years the average investment trust returned £22,195 from an initial investment of £5,000 whereas the average OEIC returned only £15,705. Indeed this is even more evident when you examine the few cases where there are equivalent funds run by the same manager in both investment trust and OEIC/Unit Trust form. The latter consistently underperform the former even though the holdings in their respective funds are identical.

2. They can use gearing. They can enhance performance further by using gearing, i.e. borrowing money at lower interest rates than the return they obtain from stock market investment. Obviously gearing adds risk, but most investment trusts use it in great moderation.

3. The company and board are directly accountable to shareholders. The company and its board of directors are accountable to shareholders in the same way as in any other publicly listed company. You can vote directors off the board, go to the AGMs and ask questions, and generally engage more with the fund management (who of course attend the AGMs). In extremis you can encourage the company to fire the fund manager (or more normally the fund management company who are contracted to the company) and replace them – it does not happen often but it’s not unknown. Compare that with Unit Trust, OEICS or ETFs where you may get a report occasionally on the activities of the fund but that is all, and if matters are seriously going wrong, there is little investors can do about it. In investment trusts, the investors effectively own the company and have all the normal rights of shareholders.

4. You can acquire assets at a discount. Because investment trusts are “closed end” funds, i.e. they generally have a fixed share capital, don’t issue new shares automatically when there is more demand for the shares from investors, or have to buy-back shares when investors wish to exit. The price of the shares is simply determined by market demand (not the value of the underlying assets). As a result, the market share price of investment trusts is often at a discount to the net asset value per share. So you can acquire the underlying assets (and their income producing ability) effectively at a discount – this can typically range from 5% to 15%. There is also a slight risk associated with this in that the “Discount to NAV” can move over time, often swayed by investor sentiment but sometimes for no very obvious reason. So you need to be wary of buying at a low discount and selling at a high discount. There is also the normal bid-offer spread on the share price as with any listed company but that is usually quite small.

Closed end investment funds are particularly suitable where the underlying assets are not easily tradable by the fund manager. For example, with private equity or direct property investments. Some “open-ended” property funds went bust when property fell out of favour and many investors wanted to get out at the same time, but the fund manager could not liquidate the assets quickly.

Pooled investments versus doing it yourself

Now, ShareSoc promotes direct investment in the shares of listed companies, rather than you relying on a fund manager to do it for you, which of course incurs charges. Also the chances are you may find the chosen fund manager only of average competence (the global pool of investment managers can only ever achieve the global average of investment management performance!). So why choose a pooled investment? The reasons may be several:

A – You may not have the competence or ability to easily invest in a chosen sector. For example, if you wanted to diversify your portfolio with some investments outside of the UK by buying shares in Chinese companies or in other Emerging Markets, doing it yourself could be very difficult. Likewise investing directly in private equity (i.e. in unlisted companies) will be practically impossible. You may know a lot about certain sectors but be more wary of others that are more specialised, such as technology or property.

B – You may simply reckon that paying an investment trust company 1.0% per annum (charges vary and can be higher or lower than that) so as to avoid having to deal with contract notes, monitor your investments and generally worry about your holdings is a good deal. Depending on how you value your own time, this could be a good trade-off. Note of course that this effective “reduction in yield” is one reason why investment trusts will arguably trade at a discount to net asset value. Also please note that like any investment, you will still need to monitor the investment if you have any sense. Funds do sometimes run into difficulties and investment trusts are no different in that respect, but otherwise they are ideal for widows, orphans or anyone simply too busy to closely manage their own stock market portfolio.

C – There are capital gains tax advantages in that any trading done by the investment trust is not subject to capital gains tax on the investment trust company whereas if you held the same underlying shares directly you might well pay that. Even if you don’t trade often, there are always the occasional take-over bid where you will be forced out. If you hold shares or funds within an ISA or SIPP then of course there is no tax in either case on income or capital gains, so the above comments relate more to direct holdings.


So in summary, investment trusts can be a useful element of any portfolio and should always be considered as an alternative to unit trusts, OEICs or ETFs. Incidentally ETFs can be very low cost but suffer from the same opaque information and corporate governance issues and are positively dangerous when they are “synthetic” ones based solely on the use of derivatives rather than the fund holding the underlying assets because they introduce “counterparty” risk.

But there are a very wide range of investment trusts, from generalist funds to specialised sector or geographic funds. That’s ignoring the even more esoteric areas of Split Capital Investment trusts and Venture Capital Trusts which the author may cover at another time.

The Association of Investment Companies (AIC) web site (www.theaic.co.uk), which is a representative body for investment trust companies, contains data on such companies, including past performance information. But as always, you are reminded that past performance is not necessarily a guide to future performance. The AIC web site now shows the overall charges in the form of “On-Going Charges” which encompasses most of them – it’s similar to what used to be called the “Total Expense Ratio”. But it does not include portfolio turnover costs (i.e. broking commissions) when many people believe it should. It’s always worthwhile trying to select investment trusts with low charges (and some are very low), but more specialised trusts with small fund sizes will always have higher costs. As with all funds, bear in mind that there is a strong inverse correlation between total charges and long term investment performance. The higher the charges, generally the worse the ultimate total return to investors.

As some investment trusts pay performance fees to their fund managers, the AIC also reports a separate “On-Going Charge” figure which includes a performance fee. See their web site for how this is calculated, but the author of this article would suggest that you may wish to avoid investment trusts that pay a performance fee if at all possible. There are many generalist funds which do not have one but more specialist funds tend to impose them. There is no evidence that performance fees improve performance, but they do of course pay out to the fund managers if they happen to be lucky, thus increasing the investors’ costs.

As with any fund, one needs to be wary of new trusts or those with a short track record