SPECIALS
The Attractions of Investment Trusts

By Stuart Watson (TMFTiger)
July 4, 2001

As pointed out in this recent message by one of our regular posters, Hallucigenia, one topic we haven't covered that much recently is the subject of investment trusts. They tend to come a poor second to unit trusts in terms of overall coverage across the financial media as a whole. There are three main reasons for this.

Far more unit trusts. First of all, there are far more unit trusts. In fact there are almost 2,000 different funds, with a total of £260b in funds under management. By contrast there are less than 400 investment trusts, collectively worth some £77b.

Less advertising. Secondly, investment trusts are companies. That means that they are not allowed to advertise their own shares, as this would be in breach of company law. So when you trawl through the weekend financial sections over your cup of coffee and bacon sandwich the glossy adverts you will see belong to unit trusts, but not their investment trust siblings. The body that represents investment trusts, the cunningly named Association of Investment Trust Companies (AITC), recently conducted the "ITs" advertising campaign to address this. Personally, I thought the adverts were pretty dreadful. Then again I think that about most adverts. Two weeks ago it was announced that the campaign was being halted.

No commission. But perhaps the main reason you don't hear as much about them is the fact that financial advisers do not get commission to sell them, unlike unit trusts. There are no 5% initial charges in the world of investment trusts. Annual management charges are typically a lot lower as well, because there is no advertising to pay for.

Herein lies one of the dilemmas of the financial services industry. Those products that get all the attention naturally have higher charges to pay for the middlemen and the costs of advertising.

Unit trusts are also open-ended, meaning that they can take on new funds to cope with extra demand. Investment trusts are close-ended, meaning they have a fixed number of shares. So unit trusts suffer from having to make forced investments or sales, depending on whether money is flowing in or out of the fund. This increases the turnover of their assets, and the extra costs this entails act as an additional drag on their performance. It is also in the interest of the unit trust manager to attract as much money as possible into the fund. But that is unlikely to be in the best interests of the existing investors.

In essence, investment trusts are designed for the benefit of the investor, whereas unit trusts are designed for the benefit of the financial services industry. The effect of this can be seen from their performance figures. Over the last 10 years, according to data from the AITC, unit trusts have turned £100 into £280 whereas investment trusts have delivered £322. This represents an annual compound rate of 10.8% for unit trusts, but 12.4% for investment trusts.

Discounts

Investment trusts do have an additional layer of risk. Because they are companies their shares are freely traded on the Stock Exchange. Their price is determined by supply and demand and therefore will tend to be different from the net asset value, the underlying value of their investments. Typically investment trusts will trade at a discount to their net asset value. But although this creates a short-term risk, the effect of discounts on a long-term holder is fairly negligible. This article has more on discounts.

Down the years trust discounts have been steadily widening. The reason for this lies in the history of investment trusts. Traditionally institutions used them rather than investing directly themselves. But now they have their own in-house teams, so they have been net sellers of investment trusts down the years. Because the price of a share reflects supply and demand, there has been a tendency for discounts to widen over the long term. However, in the last few years the average discount has reduced from 15% to 10%, partly due to the ITs campaign and partly due to the fact that trusts are now able to buy back their shares, creating more demand.

Investment Trusts vs Trackers

The Motley Fool's preference for index trackers has been well documented. We like them because their low costs mean that their long-term performance will be better than the average managed fund. Choosing a tracker is like playing the percentage shot in golf. You'll never score a hole-in-one but you should shoot a better score more often than not.

Many large investment trusts have annual charges of 0.5% or less. It is often quite hard to get an exact figure because many of them have some element of their charges based on performance. Due to their low charges, they do make a sensible alternative to your common or garden tracker as in essence they are very similar products. Many of the large investment trusts have holdings that mirror the major indices.

Choosing A Trust

The same principles apply to choosing an investment trust as to choosing any other financial product. Keep charges to a minimum as, all else being equal (and it usually is), this will translate into better performance. Most trusts have savings schemes meaning that you can invest from as little as £25 a month. Watch out for those that have minimum fees though. If you want to invest a larger lump sum buying through a online broker is likely to be cheaper, not to mention quicker.

Secondly, remember that past performance is not a guarantee of future performance. A really high flyer is more likely to come back to earth with a nasty bump. Thankfully, due to the discounts at which existing funds sit, there are few new investment trusts issued to ride trendy sectors. Why would someone buy something for £1 when you can just as easily pick it up for 90p?

The table below shows a selection of those that have assets greater than £400m and that have been around for at least 10 years. In fact many of them have been around for more than 100 years. Between them these 11 funds account for some 20% of the investment trust sector.

Name of Trust                Assets    Invested  
                                 £m   in UK - %
Alliance (LSE: ATST)           1862          52
Bankers (LSE: BNKR)             489          54
City of London (LSE: CTY)       597         100
Edinburgh IT (LSE: EDIN)       1602          95
Fleming Mercantile (LSE: FMN)  1228          85
Foreign & Colonial (LSE: FRCL) 3026          36
Monks (LSE: MNKS)               865          21
Scottish IT (LSE: SCIN)        1348          48
Scottish Mortgage (LSE: SMT)   1768          41
Second Alliance (LSE: SAT)      625          50
Witan (LSE: WTAN)              1895          56

If you want to find out more about individual trusts then the Trustnet site is an excellent place to start. The AITC site also has lots of useful information. For the unconverted looking for unit trust information AUTIF is a good place to start, as is Trustnet and the recently imported Morningstar site.

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