Investment trusts were often overlooked by investors and advisers, but that was all set to change in 2013 when the RDR kicked in, with the new regulatory regime, heralded to create a level playing field for closed-ended investment companies to compete with their open-ended cousins, Oeics.
While open-ended funds might be considered ‘traditional’ investment vehicles by some, simply because those are the types of funds that are most popular among the UK investors, in fact, open-ended funds are a relatively new concept when compared to investment trusts, which have been around for 125 years.
The first – the Foreign and Colonial Investment Trust – was launched in 1886 and there are 24 investment trusts established before 1914 that are still running today.
Investment trusts differ from Oeics in their ability to gear, their listing on a stock exchange and potential increasing share price, as well as dividend payments.
Otherwise, investment trusts are similar to open ended funds. They are run by professionals who make decisions based on each investment trusts’ mandate – which can be very specific, or broader. The reality is investment trusts can be good for diversification, allowing investors’ to invest in some areas not always accessible to open-ended funds.
Two years on from the implementation of RDR, there is evidence to suggest that investors have been backing investment trusts. The industry’s flag flier, the Association of Investment Companies (AIC), has monitored activity closely, as well as running training for nearly 4,000 advisers.
Annabel Brodie-Smith, the AIC’s director of communications, says data the organisation has collected is encouraging. “The adviser purchases of investment companies on adviser platforms gives us a strong indication of adviser demand,” she says. “Up to the end of 2014, investment company purchases by financial advisers had more than doubled since RDR.”
Data collected by the AIC, using Matrix Financial Clarity, shows that total purchases on platforms by advisers and wealth managers reached a record high of £125.3m in Q1 2015. Annual purchases for the year to end of March 2015 also reached a new high of £468.6m. First quarter investment company purchases were 14 per cent higher than Q1 2014 purchases of £109.7m and 43 per cent higher than purchases of £87.6m in Q1 2013.
Sales of investment company shares through platforms increased to £77.2m in Q1 2015 from £70.3m in Q4 2014, suggesting advisers and wealth managers are taking profits and rebalancing portfolios. However, sales were 5 per cent lower than in Q1 2014, when they were £81m.
Undoubtedly these figures will have been buoyed by the launch of Neil Woodford’s Patient Capital trust, which raised £800m earlier this year and placed a focus on the investment trust sector.
Unsurprisingly, investment trust managers are thrilled by these growth figures. Sarah Gibbons-Cook, spokeswomen for Henderson, says the uptake following RDR has been clear. “Investment trusts are more popular as a result of RDR having driven greater research, training and visibility of the closed-end sector.
“Currently most of this popularity sits with the retail investor as opposed the IFA market. Evidence on our registers is showing very strong growth from retail investors via execution-only platforms. Private wealth managers have always been a strong presence on our investment trust registers and continue to be so.”
Gibbons-Cook adds the debate should not be about choosing between Oeics and investment trusts. “Perhaps the argument is not either or, but there is a case for both, just remembering that investment trusts do have tools within their armoury providing them with a competitive advantage on performance.”
In particular she highlights that gearing is the “most prominent element of that armour” which she says “allows companies to take advantage of long-term view on a sector without having to sell existing investments to fund future investments”. Also important is the presence of an independent board of directors and the closed-end structure which means the amount of money a company can invest is fixed and not subject to redemptions.
Discounts and premiums
Investment trust “discount” should be a core consideration and, indeed, is a good indicator of these funds’ health overall. Unlike Oeics, investment trust units can be purchased at a price that could be either higher or lower that their net asset value (NAV).
The AIC’s discount statistics are another cause for cheer. “Demand for the investment company sector is currently strong, demonstrated by the average discount being close to an all-time low of 2.9 per cent. This has particularly been the case for the income sectors and alternative assets, which generate an income,” Brodie-Smith adds. “These alternative assets are particularly suited to the closed-ended sector and include infrastructure, specialist debt and property.”
Industry analysts are encouraged by continued progress in discounts. John Newlands, head of investment companies research at Brewin Dolphin and author of investment trust history titled ‘Put Not Your Trust In Money’, says: “The overall sector discount has certainly narrowed since RDR and part of this is down to investment trusts finding a new audience in the form of financial advisers.
“New and more rigorous discount control mechanisms have also played their part. While all types of fund have a part to play, I consider that investment companies have the edge.”
Structural and operational issues regarding investment trusts were used variously as both positive and negative points for investors in the past. The fact of the matter is, they are different from Oeics, and this has been noted as a turnoff in itself.
Newlands, however, insists these questions are fading. “To start with, their fund managers have an easier job because they can create a portfolio for the long term and not have to worry about having readily saleable holdings in case of redemptions,” he adds. “Secondly, investment trusts have independent boards, who hold a general meeting every year which every shareholder can attend and express their views.”
Newlands points to a few industry names that have been operating for a very long time as examples of trusts to watch for, including Witan, Foreign & Colonial or Scottish Mortgage.
“All are more than 100 years old and creating good long-term returns for investors. There are some superb smaller company funds too, such as those run by Aberforth, BlackRock and Standard Life. Doing just a little more homework can pay here and enhance clients’ investment returns,” he says.
The AIC’s point about alternative trusts is an important differentiator, because they invest in areas not always accessible to open-ended funds. Those that specialise in infrastructure are a case in point. For example, there are specialist investment trusts that invest their assets directly in the construction of private-public infrastructure projects.
These projects are built and financed through a combination of private investment and are leased back to governments, usually at a set price. This means that such funds receive payback whether or not the infrastructure project is being used, because they’ve been contracted in – usually over a course of decades.
The first was the HSBC Infrastructure Company, launched in 2006, followed by International Public Partnerships, advised by Amber Fund Management, in 2007. The GCP Infrastructure Fund, managed by Gravis Capital, was launched in July 2010, followed by the John Laing Infrastructure fund, which raised gross proceeds of £270m after an initial public offering in November 2011.
While niche sectors are interesting case studies, sectors popular among open-ended fund investors prevail in the investment trust universe. Among the most popular investment trust sectors on adviser platforms in Q1, 2015, according to the AIC, were Global and UK Equity Income, accounting for 15 per cent and 12 per cent of total investment company purchases respectively.
RDR’s forced removal of trail commission in 2013 was not enough to immediately convince everyone of investment trusts’ charms, however. Hargreaves Lansdown increased its coverage of the sector at the time to give clients a comprehensive review of the sector, but remained unconvinced. At the time, it said liquidity and volatility were causes for concern.
Brewin Dolphin’s Newlands says there are some points of caution for those considering investing in this type of fund for the first time. “What advisers who are new to closed-end funds might want to keep an eye on is trust liquidity. This is far better than it used to be and many of the larger trusts trade in excess of £1m of shares per day,” he says.
Liquidity is a problem that haunted investment trusts due to the relatively small number of investors in the space. Long-term investors might not see this as such a concern, but large wealth managers tend to take a different view, because buying large volumes of investment trust shares at a predictable price was not the easiest to achieve.
However, the increased attention on investment trusts since RDR has helped alleviate these concerns, and perhaps explains the AIC’s drive to educate investment advisors on the subject. The more investors in investment trusts there are, the less of a concern liquidity will become.
Russ Mould, investment director at AJ Bell, says the proof of investment trusts’ effectiveness is in the numbers: “A low-growth, low interest-rate environment means income remains a very popular sector with advisers and clients.”
Looking at the best performers over the past 10 years, according to the AIC, the top two both focus on biotechnology stocks, says Mould. Biotech Growth’s share price has returned £722 on a £100 investment over the period and International Biotechnology Trust has returned £518.
Also outperforming in that 10-year period, which includes the financial crisis and the 2007-09 bear market, are Standard Life UK Smaller Companies, which delivered £518 on a £100 investment, the globally focused Lindsell Train, which returned £485, and Jupiter European Opportunities, delivering £421.
Nevertheless, according to some advisers, structure and complexity remain a barrier to entry. Dennis Hall, chief executive of Yellowtail Financial Planning, says: “The issues tend to be much the same as before – the different level of complexity that discounts, premiums and gearing brings compared to open ended funds. Also the advertising ‘clout’ of open ended funds has been considerably greater than for investment trusts, and even fund managers with a dual offering are not promoting the closed ended fund with as much vigour as their open ended funds.
“That’s a pity, and it to the detriment of the longer term investor,” he adds. “Survey after survey delivers evidence that investment trusts out-perform Oeics and that charges are lower, but advisers are by and large wary of recommending the former. Reasons appear to be the added risk of discounts or premiums and gearing, as well as liquidity issues. But there are many trusts that have relatively stable differences between prices and NAV and no practical liquidity issues.”
Without doubt, a big benefit of investment trusts was surely costs, an area that they previously held a clear advantage over Oeics, due to lack of commission paid, but since RDR this advantage has gone. With some open-ended unit funds now charging as little as 0.30 per cent, the challenge for investment trusts is to find ways to bring costs down further to maintain this key differential.
Henderson’s Gibbons-Cook agrees: “Their charges are not always lower than other funds but are extremely competitive.
The removal of commission in the RDR was hailed as a clear boost for investment trusts. Sales have increased in the past two years and performance has backed this up, but some advisers are still wary.
Investment trust – Rich history
- The first investment company, Foreign & Colonial, was formed in 1868. It’s founding principal was “to provide the investor of moderate means the same advantages as the large capitalists in diminishing the risk…by spreading the investment over a number of stocks”.
- Launched in 1928 as the Foreign Railways Investment Trust, and then acquired by the Scottish-estate owning Cayzer family in 1951 as a holding company for their shipping interests, Caledonia Investments (listed in London) re-launched as an investment company 1987.
- In February 1873, Robert Fleming launched The Scottish American Investment Trust in Dundee.
- The Scottish Investment Trust launched on 27 July 1887 and was founded by John Dick Peddie, an Edinburgh architect.
- The Brunner Investment Trust, now managed by Allianz Global Investors, was established in 1927. Sir John Brunner, who died in 1919, launched the businesses, which ultimately led to the trust’s launch. The family maintains a big interest until today.