After years in the doldrums, investment trusts — those venerable pooled funds with names like Foreign and Colonial and City of London — are in danger of becoming fashionable. There are good reasons why they should be better known. They offer the possibility of high returns at low cost, as well as access to exotic asset classes that would otherwise be out of reach. They can be a way of spreading risk, if you do not have the time or the inclination to pick individual stocks for yourself. And they are generally cheaper than other vehicles for collective investment, such as unit trusts; the idea is that as little of your money as possible is eaten up by the layers of charges which Warren Buffett’s lifelong investing partner Charlie Munger vividly described as ‘the croupier’s take’. They are also surprisingly fascinating, or so I’ve found as a self-taught enthusiast.
For decades, City folk have favoured investment trusts over unit trusts and open-ended funds. Independent financial advisers ignored them, however, since they did not pay any commission. That, and the fact that unit trusts are easier to explain, has meant that the open-ended sector has dominated. Now, thanks to the Retail Distribution Review, the playing field has been levelled. From April, funds will not be allowed to pay commission to IFAs. So it is no longer in advisers’ and brokers’ interests to ignore investment trusts. Already retail investors are cottoning on to the advantages, and last year saw a 66 per cent rise in purchases of investment trusts through fund supermarkets.
Because investment trusts don’t pour money into marketing, they have been able to keep their charges under control. (The menace of performance fees is creeping in, but that is a discussion for another time.) Many, after all, were set up for canny Scotsmen. Take Scottish Mortgage, which I hold shares in. It was founded in 1909, by Alastair Macgregor and Carlyle Gifford, to profit from the rubber boom in the Malay peninsula by lending money to young Scots planters. Today it is one of the best-performing global trusts; it has held or raised its dividend for nearly 80 years — for an ongoing charge of half a per cent (0.51 per cent).
Not only are investment trusts cheaper on the whole, but they also perform better than unit trusts. Alan Brierley, a number cruncher from Canaccord Genuity, compared trusts and funds operating in the same areas. He found that over the past five years trusts outperformed funds in 18 out of 19 cases.
But if you’re interested in finding bargains in this sector, it is vital to arm yourself with knowledge. All the data you need is freely available online. If you already own shares in a trust, you can go to the AGM and ask the managers questions — something you cannot do with unit trusts. Investment trusts also have an independent board of directors, who can fire a poorly performing management team and replace them. The directors also keep an eye on the level of borrowing (or ‘gearing’): trusts can borrow to enhance returns in rising markets; on the other hand, losses can be magnified if markets plummet.
It is a good idea to understand the slightly trickier structure of investment trusts, as opposed to open-ended funds. Basically, the ‘closed-end’ structure means that the company is divided into a set number of shares and the manager starts with a fixed sum of money. That frees him to invest in illiquid, long-term projects — infrastructure, say — without worrying about having to flog off the assets in a hurry if investors panic and demand their money. (Unit trusts, in contrast, can be forced to sell their holdings at rock-bottom prices to meet redemptions in a market crash — which is a distraction for the manager, to put it mildly.) This also means that by putting your money in investment trusts you can support useful undertakings, such as building railways or developing cures for deadly diseases. The Biotech Growth Trust (which I hold) invests in companies that research treatments for HIV and hepatitis C. It can be a profitable area: that trust has returned 298 per cent in five years.
The investment trust universe attracts some of the brightest managers and they often stay put: it’s not uncommon to see a trust in the hands of the same manager for ten years or more. Many risk their own money in their ventures. It’s reassuring for investors to know that ‘le patron mange ici’. Max Ward, for example, has a stake worth millions in the Independent investment trust, and Caledonia still looks after the fortune of its founders, the Cayzer shipping family.
The closed-end structure does come with specific risks. If investors lose confidence and lots of them sell, then the share price can fall below the value of the underlying holdings, the ‘net asset value’. In a plummeting market, this can be worrying. But in some cases, it can present an opportunity to snap up a bargain. If you judge that the discount to NAV is greater than it has been historically — you can find this information online — then you may decide that the trust is going through a temporary bad patch, and the shares are good value. To paraphrase the great Ian Cowie, now of the Sunday Times, where else can you get £1 of underlying net asset value for 88p in a £2 billion global company that has increased its payout every year for 46 years? That example is Dundee-based Alliance Trust, founded in 1888; its shares can be bought at a 12 per cent discount.
Investment trusts can be moreish. You have to be careful not to ‘collect’ them, over-diversifying and wastefully churning shares. Some are actually designed to be one-stop shops, like Personal Assets, an unusual vehicle run from a flat in Edinburgh’s New Town, which holds gold, fixed interest and only half in equities. (For transparency: my wife holds that in her Sipp.)
I keep tabs on a small group of experts, including the specialists on my newspaper; also Fiona Hamilton, a writer based in Stirlingshire, who knows a huge amount about trusts; John Newlands, Brewin Dolphin’s head of investment trust research and a former naval officer, who talks to managers all the time and has written several company histories; and John Baron, the colourful Tory MP, who runs two ‘live’ portfolios in the Investor’s Chronicle and has written the FT guide to the sector.
I notice that investment trust enthusiasts tend to be obsessive, and fundamentally optimistic. They believe that the market rewards loyalty. I like this. I also like the fact that trusts have retained their distinctive characters, and stayed out of the hands of the marketing men. You have to dig them up for yourself. All this is interesting. ‘Saving’ doesn’t have to be boring.
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Andrew M. Brown is the Sunday Telegraph’s comment editor.
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