Changes to financial advice could bring investment trusts out of the shade.
Here's a prediction: expect to hear a lot more about investment trusts in the years ahead. Why? Because the era of commission-based advice is finally coming to an end, and will be outlawed in 2012.
And when people pay advisers a fixed sum for their advice -- and then go on to keep a beady eye on what that paid-for advice has actually delivered -- advisers will have a much greater incentive to point people towards investment trusts.
Or, to put it another way, much less of an incentive to point people towards unit trusts, which just happen to pay advisers a juicy commission in respect of the investments that their clients make.
Simply put, investment trusts have been going a lot longer than most unit trusts, deliver pretty much the same active investment management (as opposed to a passively-managed tracker), and cost investors rather less -- partly, of course, because they don't pay commission to advisers.
In short, if an adviser has ever sold you a unit trust investment fund, there's a fair chance that an investment trust would have done much the same job, at a rather lower cost.
A Well-Kept Secret
Beyond simply saying that investment trusts are rather like publicly-quoted unit trusts that you can directly buy shares in, just like any other quoted company, I'm not going to get into the detail of explaining what they are. The Fool isn't short of advice on understanding -- and buying -- investment trusts. Savvier Fools -- and Fool writers -- hold investment trusts in their portfolios. Here, for example, Fool editor Stuart Watson, himself an investment trust investor, highlights their strong performance and surveys the major players.
Yet, for the typical investor, investment trusts are hardly front of mind -- despite the fact that several have been going for over a hundred years, and are among the UK's largest businesses.
No wonder, perhaps, that one investment trust manager regretfully describes them as 'a well-kept secret'. Yet two investment trusts, Alliance Trust (LSE: ATST) and Foreign & Colonial Investment Trust (LSE: FRCL), are members of the FTSE 100, and date back to 1888 and 1868 respectively.
Under the radar screen
There are, to my mind, several reasons for investors' lack of awareness of the role that investment trusts could play within their portfolios -- especially that part of their portfolios reserved for collective diversified investments.
First, as we've seen, advisers have no incentive to point their clients towards investments that don't earn them a commission. That isn't to say that some don't -- merely to point out that the incentive system is stacked against this happening, and that the FSA has now moved to eliminate the possibility completely.
Second, most investors have a natural inclination to only invest in what they know or understand. While Peter Lynch and Warren Buffett are often associated with this advice, it's simple common sense. And I think it's fair to say that investment trusts are guilty of inadequately explaining themselves to retail investors, although that's partly down to rules relating to financial advertisements.
Investment trusts' names don't help. The Scottish Mortgage Investment Trust (LSE: SMT), another very major player, is nothing to do with mortgages, and little to do with Scotland. Instead, like the Scottish American Investment Company (LSE: SCAM), it is one of four global growth investment trusts jointly managed by a venerable Edinburgh-based organisation called Baillie Gifford, founded in 1908.
Third, the investment business model can be confusing. Alliance Trust, for instance, operates a savings arm that sells other companies' unit trusts for investors to hold within their ISA and SIPP wrappers. In effect, it's offering investors the opportunity of investing in its competitors, rather than itself. It may make commercial sense, but it's hardly a model of clarity. Even more confusingly, it also sells its own unit trusts.
Fourth, it's not unknown for investment trusts to trade at a net discount to their underlying assets. In fact, it's quite common, and it's easy for commission-based advisors to exploit this as an excuse not to point investors towards investment trusts. After all, for a company to be worth less than the shares it owns doesn't sound too clever. In fact, it's a buying opportunity -- which is why Alliance Trust has recently attracted the attention of investors hoping to make a capital gain as the discount narrows.
Be prepared
At long last, investment trusts are starting to address some of these issues. Baillie Gifford and Witan, another investment trust manager, have been engaged in some quite clever marketing, for instance. Slowly, the message is getting out.
For investors wanting simple, diversified, low-cost stock market exposure -- especially low-cost global stock market exposure -- investment trusts have lot to offer. And, rather like Exchange Traded Funds, they're not complicated given a little basic research. You may not hold an investment trust today -- but I suspect you might well do in the future, as the clouds of commission-based advice start to disperse.
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