Investment trusts should revel in their distinctiveness and astonishing history of longevity and resist any moves by managers and advisers to make them look like open-ended funds
One of the things that is getting my goat these days is the determination on the part of some market commentators, and indeed some wealth managers and IFAs, to try and make investment trusts look like open-ended funds whilst ignoring those additional characteristics that single out investment trusts as one of the best ways for retail investors to invest in the equity market.
Many investment trusts have long and distinguished histories with the oldest going back as far as 1868, when the first was launched with the aim of providing the ordinary man with access to a pooled investment of domestic, and more often, international investments. This formula, which has served generations of investors so well, led investment trusts to be called the City’s best kept secret.
Indeed, I remember the late great Philip Chappell, who was director of the Association of Investment Trust Companies some 25 years ago, saying that it was an unkind jibe yet true that City experts put their clients into better marketed competing products whilst investing in investment trusts themselves. I believe this unkind jibe remains true today.
There is good reason for these City experts to put their own money in investment trusts as research produced by the analyst Alan Brierley at Canaccord Genuity consistently shows that, on average, investment trusts outperform open-ended funds in more sectors than vice versa. So what changes are being proposed that might take away that investment trust distinctiveness and make investment trusts more like open-ended funds?
The first of these are zero discount control policies. The object of these is to use share issue and share buyback powers to ensure the trust’s share price trades at or around the net asset value. The key benefit is improved liquidity for both buyers and sellers and the knowledge that the shares will not drift out to a wide discount or premium. This is fine and dandy, but if that is your worry as an investor then buy a single-priced open-ended fund and do not seek to undermine one of the key attractions of the investment trust structure.
Investment trusts are “closed-ended” and the effect of zero discount control policies is to make them “open-ended”. Being closed-ended enables the portfolio manager to take a longer term view of investment without having to worry about a redemption stream. Portfolio managers of open-ended funds have to consider holding cash to fund redemption streams or else accept that they will have to sell stock to do so.
In a market crash situation, or indeed a simple rapidly falling market, this may prove difficult to do and the portfolio manager may be forced to sell those stocks he can, rather than those he wants to sell, in order to satisfy the redemption stream. Being forced to hold cash or being forced to sell stocks will both inevitably have a negative impact on the performance of the portfolio. Those of us with long enough memories to remember the 1987 crash know how true this is as the managers of investment trusts were able to buy and sell to re-shape their portfolios in the light of the crash whilst managers of open-ended funds just worried about selling stocks to fund redemption streams.
Of course zero discount control policies come from a concern about the discount and premiums at which investment trust shares trade to their NAV. Investment trust investments are medium-to-long term investments with typical holding periods of five years or more. Over that time period the difference between the buy discount and the sell discount is likely to be a tiny proportion of the return on the investment. I therefore believe that investors can happily “discount the discount” and focus on the quality of the portfolio manager, which should be the key determinant of any investment decision.
The second way in which investment trusts are being pushed into being open-ended is management fees. The standard fee for the “clean” share class of an equity open-ended fund is 0.75 per cent and some commentators say investment trusts should scrap their performance fees and fall into line. Well, some have, and often at base fee levels much lower than 0.75 per cent but the majority are sticking with their performance fee structures.
In my view they are right to do so as they offer investors a choice. I think many investors would prefer to pay a base fee lower than the 0.75 per cent standard for an open-ended fund and then share some of any outperformance above a suitable hurdle, with the manager up to a reasonable cap. Paying lower management fees when performance is poor and higher fees when performance is good seems to be an attractive formula.
There are other distinctive features of investment trusts that fortunately have not yet come under the spotlight, which help make them such an attractive proposition for investors. First is the existence of an independent board of directors who provide an invaluable governance role with the interests of shareholders their primary concern, both encouraging and challenging the portfolio manager and sharing their insights into the market.
Second is investment trusts’ ability to gear the portfolio by borrowing money with the objective of enhancing returns for shareholders. This has proved an invaluable capital and income enhancing strategy for well managed investment trusts.
The combination of all these things makes investment trusts distinctive, and goes some way to explaining their astonishing longevity. I believe investment trusts should revel in their distinctiveness and resist any attempts to homogenise them with open-ended funds. Generations of investment trust investors will tell you that if “it aint broke don’t fix it”!
James de Sausmarez is director and head of investment trusts at Henderson Global Investors