Big investment trusts provide diversification at a low cost.
The saying "don't put all your eggs in one basket", a warning to avoid concentrating all of your energies in the one project, was popularised by the English translation of Cervantes' Don Quixote and it remains relevant to today's investors.
If you put all your investment eggs into a single basket, and the investment does well, then you'll be pleased. However, as all too many investors found out over the years, should the investment go down the plughole this will have a seriously detrimental effect upon both your financial and mental well-being.
An alternative strategy is to diversify your investments by spreading your money between several investments so that the effect that any one investment has upon your overall net worth is relatively small. The most common way to diversify is to hold a mixture of shares, fixed-interest investments (e.g. gilts), property, cash and possibly commodities, but also to ensure that some of these investments are exposed to overseas economies so as to reduce your dependence upon the UK economy.
An alternative is to buy shares in an investment trust which owns a diversified investment portfolio. The oldest investment trust in the world is the Foreign & Colonial Investment Trust (LSE: FRCL) which was formed in 1868 as a collective investment vehicle in order to give "the investor of moderate means the same advantages as the large Capitalists, in diminishing the risk of investing"
1 Share, 600 Companies
Consider what happens if you choose to buy shares in 600 different companies. Asides from having to pay a fortune in dealing costs (we're talking both UK and overseas companies), you then have to deal with the hassle of monitoring 600 investments and for a portfolio of that size that would take a lot of work. Few of us have the time or the inclination for that!
The Foreign & Colonial Investment Trust (FCIT) owns shares in more than 600 companies spread over some 30 countries and has total assets of well in excess of £2 billion. If you buy shares in an investment trust like this, you simplify a lot of the investment process because it gives you lots of diversification within the one investment.
FCIT's managers run the portfolio against a benchmark that is 40% of the FTSE All-Share Index and 60% of the FTSE All-World excluding UK. The most recent portfolio update shows that the managers are closely following this benchmark with the investments being split in the following proportions: 40% UK, 23% North America, 15% Europe, 14% Pacific and 8% elsewhere.
If you look at the update you'll see that it contains many well-known multinational companies such as HSBC (LSE: HSBA), RioTinto (LSE: RIO)and Vodafone (LSE: VOD).
The Numbers
When looking at an investment trust the key piece of information is its net asset value (NAV), rather than its profitability. As investment trusts don't operate any businesses, their profit & loss account is relatively unimportant because it largely consists of income received, fees and expenses paid to the managers and income tax (investment trusts don't pay capital gains tax upon their investments).
Consequently, standard investment tools such as comparing P/E ratios aren't of much use when looking at investment trusts.
FCIT's most recently published net asset value (NAV) is 313.5p whereas the current share price is around 280p. It is perfectly normal for an investment trust's shares to trade at a discount to their NAV; if they are trading at a premium that is generally a sign that they are overvalued.
The directors have confirmed that the trust will maintain its annual dividend of 6.45p for the current year, putting the shares on a 2.3% yield.
For comparison purposes, one year ago its shares were 221p; five years ago they were 193p and back in early 2000 the price was 235p. Over each of these periods its shares have outperformed the FTSE 100 index, which is what many private investors use as their benchmark. In large part, this outperformance has been due to the overseas investments.
Low Charges
Naturally FCIT isn't managed for nothing but investors can take heart in its low running costs. It is managed by F&C Asset Management (LSE: FCAM) and its total expenses for 2008, including the managers' fees, were 0.58% of its assets. That's a lot less than most other investment trusts and it saves you from having to spend time monitoring the investments and dealing with the paperwork!
Never forget that time spent doing any task is time which could have been spent elsewhere, perhaps on something more beneficial (this is what economists call "opportunity cost").
In case you're wondering where else you've seen the F&C name, they are the shirt sponsors of Birmingham City Football Club, who are currently in the process of extending their record unbeaten streak having last weekend held the mighty Manchester United to a well-earned 1-1 draw in one of the few games that wasn't snowed off.
The Foreign & Colonial Investment Trust offers investors an easy way to diversify their investments throughout the world at a relatively low cost. You can buy shares through your dealing accounts or directly from the managers using their savings plan.
More from Tony Luckett:
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