Take the following trusts: Allianz Technology Trust (LSE:ATT), HgCapital Trust (LSE:HGT), and JP Morgan American Investment Trust (LSE:JAM). These products have delivered a stunning average annual return of 13.7% over the past decade.

For a modest management fee, investors have tapped into the experience of seasoned fund managers to realise those decent profit. And they’ve got exposure to thousands of different global shares without having to pay a transaction fee for each one.

Here’s why I think these top investment trusts should continue delivering exceptional returns.

Tech titan

Allianz Technology Trust has harnessed the enormous growth potential of US tech shares to brilliant effect. Since 2015, it’s delivered an average annual return of 9.7%.

Fears over Magnificent Seven shares like Nvidia, Amazon, and Microsoft abound due to their elevated valuations. This could prompt a pullback, but I think they’ll continue rising strongly over the long term as our lives become increasingly digitalised.

With 51 different holdings, the Allianz Technology Trust provides multiple ways to capitalise on the tech revolution. So if artificial intelligence (AI), for instance, fails to live up to its early promise, segments like cybersecurity, cloud computing, and robotics could still lift the trust to the stars.

Targeting hard-to-reach places

The HgCapital Trust gives investors access to companies that aren’t listed on stock exchanges. These number 57 in total across the software and services sectors. Since the mid-2010s, it’s provided an average annual return of 16.4%.

The companies it holds enjoy recurring revenues and high margins, and are spread across many industries including tax and accounting, payroll, fintech, insurance, and healthcare. This, along with a wide reach across Europe and North America provides excellent diversification.

I expect HgCapital to continue outperforming, though the cyclical nature of its holdings could leave it vulnerable to temporary economic downturns.

Big US returns

The US stock market has been a formidable cash generator over the long term. Since 2015, it’s driven a 15.1% average annual return for the JP Morgan American Investment Trust, with its laser focus on Wall Street equities.

With a high weighting of technology shares, the trust has considerable long-term growth potential, as that whopping return indicates. Just under 30% is locked up in these high-performing shares.

Other well represented sectors include financial services, telecoms, healthcare, and discretionary consumer goods. In total, it holds shares in more than 250 multinational companies, providing excellent growth and income opportunities alongside diversification for safety.

Investor rotation out of US shares may dent JP Morgan American’s returns. But on balance, I’m expecting it to enjoy another strong decade.

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The calculation’s simple: a second income of £3,000 a month works out at £36,000 a year which, when divided by a 6% yield, gives a figure of £600,000. Thanks to the ISA’s tax benefits, an investor doesn’t have to pay a single penny from their portfolio to the taxman.

That £600k may look like a substantial sum of money. And to be fair, it is. But thanks to two key forces — the power of compound returns, and the enormous growth potential of the global stock market — hitting this magic number is more than achievable over time.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

Building a £600k ISA

According to Shepherds Friendly, the average Briton invests £514 a month. At this level, someone who uses this to invest in an ISA over a couple of decades could realistically target a £3k second income.

Let’s say we have an investor who achieves an impressive average annual return of 11.2%. That rate of return matches the performance of the MSCI World Index — which tracks the performance of 1,325 global shares — over the past decade.

Excluding trading fees, stamp duty and other costs, our investor would have turned a £514 monthly investment into £602,842 in just over 22 years. That would comprise total deposits of £137,238, and more than £465,604 in compound returns, with dividends reinvested.

Trust exercise

Investing in the stock market can be unpredictable. But over the long term, it’s consistently (and often handsomely) rewarded patient investors.

Investors can also smooth out temporary volatility and manage risk by purchasing investment trusts and/or exchange-traded funds (ETFs). These diversified instruments can hold a wide range of assets, allowing a smooth return across the economic cycle.

Take the HgCapital Trust (LSE:HGT) as an example. Delivering an average annual return of 20.5% between 2014 and last year, this product could be a great trust for our investor targeting that £3k passive income to consider. But remember, past performance isn’t always a reliable guide to future returns.

With net assets of £2.4bn, the trust’s focused on fast-growing software and services businesses that aren’t listed on stock exchanges. These include the likes of Visma, whose software is used for functions like payroll, procurement and accounting, and Howden, which is the largest insurance intermediary outside of the US.

In total, HgCapital has holdings in more than 50 companies. Though it’s still vulnerable to economic downturns, its diversification by end market and geography helps spread risk and deliver impressive results. On a trailing 12-month basis, its portfolio has delivered sales and EBITDA growth of 20% and 21% respectively.

Building a passive income of £3k a month with an ISA isn’t simple. But with proper research, regular investing and patience, it’s totally achievable.

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That sort of performance has clearly not gone under the radar. The daftly named HgCapital has a market capitalisation of £2.4bn. Despite that, it trades on a price-to-earnings (P/E) ratio of just 10.

Now, I find P/E ratios less useful in assessing investment trusts (where earnings typically come from investing) compared to companies (where they ordinarily come from operations). But a P/E ratio of 10 is fairly low – could investing in HgCapital Trust offer my portfolio some long-term opportunity?

Approach proven over time

Past performance is not necessarily indicative of what will happen in future.

But I do think it is worth noting that the past five years have not been exceptional ones for this investment trust. Over the past 10 years, HgCapital Trust shares are up 382%. Over 20 years, they are up 945%.           

The trust’s objective is to provide shareholders with consistent long-term returns that beat the FTSE All-Share Index. It aims to do that by investing mostly in companies that are not listed on the stock market and where there is the potential to unlock value through strategic or operational changes.

The trust’s biggest investment focus is software, where it has around 50 holdings.

As it focuses on unlisted companies, many of these firms may not be well known to most investors. For example, Fonds Finanz is a financial intermediary pool focused on the German insurance sector. So, few (if any) small British investors are likely to be familiar with it.

That makes it harder to assess HgCapital’s portfolio in the way one might for an investment trust like City of London or Scottish Mortgage, where most holdings are large, listed firms.

But one advantage is that by hunting mostly among unlisted companies, HgCapital may be able to tap into growth stories that still have a long way to go. Even just a few of those doing brilliantly could be enough to help the investment trust perform well overall. Its long-term value creation speaks for itself.

One to consider

Can things continue well?

Of course that remains to be seen. A weakening tech market risks hurting valuations for firms across the sector, both listed and unlisted. Meanwhile, as other investment trusts try to copy HgCapital’s successful strategy, it could become costlier to buy into some promising early stage tech opportunities.

Still, the market is large and HgCapital’s experience gives it some advantages, such as a thick book of contacts, credibility as a potential investor and understanding of how the tech space is evolving.

Given those long-term advantages and its proven approach, I see it as a potential bargain that investors should consider.

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Like most funds, it aims to provide consistent long-term returns that outpace a major index, such as the FTSE All-Share. And it’s doing a good job. Annualised returns over the past 10 years are 18.8%, in contrast to 5.3% returned by the All-Share.

The focus on private equity gives the fund a unique value proposition, providing exposure to companies that have issued shares but not traded on an exchange. Some companies don’t want to be listed, others are just too small or lack sufficient shareholders.

One cool thing about investing in unquoted companies is the potential for higher growth if they have small market caps. Companies with large market caps can have limited growth potential because it takes a LOT of money to move the price. The trust could also have more influence over the companies it invests in with few shareholders. Often, this lets it provide expert advice and guidance to small start-ups with that X-factor for success.

Here’s what caught my eye: the trust is up 45.5% in the past year. That’s far higher than the GB Capital Markets average of only 10% — but is it higher than other FTSE 250 trusts? Alliance Technology Trust is up 54% in 12 months. But over five years, HG Capital has outperformed Alliance, with a 123% gain compared to ‘only’ 114%.

Plus, it pays a dividend. Add that, and HG’s five-year returns are 146% while Alliance, with no dividend, doesn’t budge.

Risk factors

While the above figures are impressive I mustn’t forget the golden rule — past performance is no indication of future returns. Unlisted stocks are inherently risky due to the lack of publicly available information, so shareholders are entirely reliant on the decisions of the fund managers. Yes, smaller companies tend to do well during times of economic prosperity but they also tend to nosedive quickly when markets turn sour.

Importantly, with the share price consistently rising for several years, HG Capital is trading only 2% below its net asset value (NAV). A year ago, it was around 30%. I always check NAV when looking at investment trusts, as it gives a good feel for the combined overall value of the trust. If the share price is selling at a discount (lower than the NAV), then I’m interested. But at a premium above the NAV? I’m thinking it could be overvalued.

So, yay or nay?

If the HG Capital price continues to rise or the NAV falls due to bad investment decisions, shareholders will soon be paying a premium. But its NAV looks good – it’s down a bit this month but has been increasing steadily for the past three years, with only a few minor dips.

As such, I’d expect the price to either correct soon or trade sideways until markets improve. However, since I’m looking at investment trusts over decades rather than years, short-term movements are inconsequential. In the long term, HG Capital looks like a great investment that’s firmly on my list for next month’s buying round.

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