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What is an investment trust?

And is there one for you?

24 May 2014

9:00 AM

24 May 2014

9:00 AM

A strange language is spoken on Planet Finance. It often seems designed to baffle the average investor, and save the richest pickings for the professionals. Take, for example, ‘investment trusts’ — they’re investments, certainly, but they are not trusts. And since blind faith is the last thing to invest in any money-making exercise, the two terms make an odd pairing.

The most important decision an average investor has to make is to trust their money with a good manager in a promising sector. And this is the main attraction of Investment Trusts. If you fancied a bet on Japan, for example, your first thought may be a straightforward fund, like Fidelity’s Japan Fund, with a 1.5 per cent annual management fee. But why might an investor instead go for an investment trust like Schroder’s ‘Japan Growth Fund Plc?’ And why does an investment fund pose as a company — with directors, plc status and its own separate stock exchange listing?

Investment trusts tend to offer great flexibility, and make it relatively easy for investors to hold their professional advisers to account. Running costs are often more reasonable than with the simpler (and more heavily advertised) funds. The flexibility comes because investment trusts manage a fixed pool of capital, often obtained in one go from investors at the time of foundation. The trust managers set out to try to make that pool of capital grow in value, by investing it as best they can. And unlike your normal fund, the assets of an investment trust are not added to, or subtracted from, every time an individual investor buys or sells.

This makes investment trusts more panic-proof — they don’t have to sell the underlying investments to meet the demands of those that want out. If a stock-market crash comes along, they will feel less pressure to sell out at a bad time. If the original investors want to exit, they simply sell their shares in the trust. If you sell shares in Google, there is no immediate impact on Google one jot — it has just as much money as it did before. The same rules apply to an investment trust.


Investment trusts, unlike funds, can also borrow. Debt adds a layer of risk, but it also gives good money-managers the chance to magnify returns. And the bad money-managers? Here’s where the board of directors come in. It is their job to protect the interests of the original investors. And if the directors are found lacking, shareholders can vote to get rid of them.

To be sure, paying people to sit on boards adds to the running costs of an investment trust. But there are savings: investment trusts tend not to advertise that much, and shy away from paying financial advisers to sell their wares. This means investment trusts have a relatively low profile.

That said, it’s fairly easy to find out about them — if you know where to look. Comparison websites of outfits such as Morningstar (www.morningstar.co.uk) and Citywire (www.citywire.co.uk) give you an idea of the range. At one end of the spectrum are generalist investment trusts — such as Alliance Trust, Witan and Foreign & Colonial. They own shares in all sorts of companies across the world. Foreign & Colonial — the oldest investment trust, founded in 1868 — has about a third of its assets in the United States, another fifth in Britain, and the remainder spread around the rest of the globe. Among its biggest individual investments are GlaxoSmithKline, the drugs company; HSBC, the bank; and BP, the oil producer. But though these blue-chips make up the larger holdings, they account for only 1 to 2 per cent of the money held by F&C.

Investment trusts come into their own at the specialist end of the spectrum. If you fancy the idea of venture capital, for instance, you might well look to an investment trust. Early-stage financial investments cannot easily be turned into ready cash to satisfy instant redemption demands. Hence 3i — originally called Investors in Industry and set up in the aftermath of the second world war to finance young business ventures — works well as an investment trust.

Another, quite different example is the Scottish Oriental Smaller Companies Investment Trust. Its recent track record shows it is possible to make handsome returns from Asian companies worth less than $1 billion. Its freedom to invest, however, would be severely curtailed if it had to run with the herd, and buy or sell as its own investors came and went. Investment trusts are better able to exercise that ancient trick of investment — be greedy when others are fearful, and fearful when others are greedy.

But in some ways, investment trusts are even riskier investments — because there is often a difference between their underlying value and their stock-market value. The so-called ‘discount to net asset value’ may be as much as 20 per cent or more, but it varies with market conditions, and while shifts in the discount can help overall returns, it can also exaggerate losses. Such added uncertainty makes it sensible to think about drip-feeding money into (and out of) investment trusts. Monthly or quarterly subscriptions are practical for those of us wage slaves without massive lumps of capital sitting around. But regular saving also lets investors reduce one of the biggest risks there is — timing. Sound investments can disappoint if the market, for its own reasons, elevates the price at which you buy into investment trusts. Sell at the wrong time and it’s just as bad.

For the record, I have money where my mouth is: I have a regular savings scheme set up with Alliance Trust. It invests in all sorts of things, and had admirably low costs. But overall, I’m fairly cautious. I’ve been writing about trusts for 20-odd years now and, for what it’s worth, I’m not sure that now is a great time to pile into the kind of stocks and shares that underlie many of these investment trusts. A lot of them look quite expensive. But if your aim, like mine, is to build up some sort of financial security for the future — and make investment trusts part of your portfolio — now is as good a time as any to start.

Robert Cole is a columnist for Reuters Breakingviews.

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