COMMENT
Investment Trusts Deliver Big Rewards

By Ed Bowsher (TMFArkle)
January 5, 2006

The Motley Fool has been a long-standing fan of tracker funds. We like their low charges and their simplicity. That said, no investment vehicle is perfect; even trackers. The problem with trackers is that, by their very nature, they can't beat the market.

So if you want to try and outperform, you need to look elsewhere. One option is investment trusts. You won't have to pay high charges for many trusts, and they also offer a chance of market-beating performance.

Investment trusts are similar in many ways to actively managed unit trusts. There is, however, one big difference.

Investment trusts are closed-ended funds. If you wish to buy a stake in a particular unit trust, the fund management company issues new units just for you.

But if you wish to buy into an investment trust, you have to buy pre-existing shares from a current shareholder. Indeed, investment trust shares are traded on the stock market. This means that the fund's share price usually doesn't correspond exactly with the net asset value (NAV) of the fund's investment portfolio. In fact, most investment trusts trade at a discount to their NAV.

If you pick the right fund, its NAV may rise. If the fund's discount narrows at the same time, you can benefit from an investment "double whammy." Of course, the risk is that the discount may widen. So if share prices fall, you may find that your investment trust has dropped by more than the market as a whole.

Discounts tend to narrow if the stock market is doing well. They widen when times are bad.

So what should you look for in an investment trust?

Looking at discounts is definitely a good idea although it's best not to become obsessed by them. If a fund is trading at a 30% discount to NAV, there may be a good reason.

You also need to consider past performance although there's no guarantee that last year's winners will continue to do well. Check to see that the manager who has delivered the outperformance is still running the fund. You can find this information at the Trustnet website.

The most important factor is picking the right investment style or sector. If you think that growth shares will do well for the rest of the decade, look for a UK growth fund. If you think that Japan is about to take off, there are plenty of Japanese funds out there.

Finally, here's the lowdown on three investment trusts that have caught my eye:

Merrill Lynch World Mining Trust

If you think the resources boom is set to continue, then have a look at this fund.

It owns shares in many of the big mining companies such as BHP Billiton (LSE:BLT), and trades at a 9.4% discount to its NAV. Its share price has soared by 193% over the last three years, but there could be more to come.

Throgmorton Trust

This fund is managed by Roger Whiteoak, a highly respected UK smallcap stockpicker. It's trading on a surprisingly wide 16% discount, yet its share price has jumped 177% in the last three years.

Alliance Trust

The Alliance Trust is a giant fund with a £1.7bn market value. It invests in growth and income shares across the world. It trades on a 12% discount, and the shares have risen 62% in the last three years. Last year, the trust reported a total expense ratio of 0.33%, so this is a cheap and simple way to gain exposure to the global stock market.

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