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Guide to Investment Trusts
Investment trusts are a great way to invest in the stockmarket, but until recently they remained an investment backwater, used predominantly by a relatively small group of professional investors.
But having hidden their light under a bushel for decades, inveestment trusts in recent years have started to market themselves more effectively and broadcast the message of their often superior investment performance.Colourful history
Anyone new to investment trusts will be struck by some of the exotic names, which are largely a function of their history. The UK’s oldest investment trust, Foreign & Colonial, was established in 1868 and is still thriving today. It was originally set up to give modest investors the same opportunities as wealthier investors to invest in a large number of UK and international shares and it is still performing the same function today.Nowadays, it is fashionable to invest in ‘emerging markets’ such as China but investment trusts have always done so. For instance, they invested in the companies which built the first railroads in the United States and laid the first submarine telegraphic cables at the end of the 1800s.
The unusual names of some investment trusts today are a reminder of their early days. Scottish Mortgage has nothing to do with mortgages nowadays, but when it was launched in 1909 at the height of the rubber boom, it offered mortgages on rubber plantations in the Far East.
Other unusually named trusts include Bankers and Monks. Bankers was actually set up by a group of bankers. However, Monks had nothing to do with a religious order but was given its name by its original investment managers who were based in Austin Friars, a street in the heart of the City of London.
Some trusts were first set up to manage the money of wealthy families such as Brunner and Witan. More recently launched trusts have also been given some unusual names, such as Aurora, Majadie and Primadona.
Click on the links below to move to the section you wish to read:
- Investment trust returns
- Charges
- Different types of share
- How do I buy an investment trust?
- How do I check the performance of investment trusts?
- How do investment trusts compare with unit trusts and Oeics?
- A selection of leading investment trust companies
- A selection of leading investment trust companies
- Why does my financial adviser never mention investment trusts?
Investment trusts today
Investment trusts today are just as go-ahead as they were in the past, with specialist trusts investing in India, China and Russia, or sectors such as alternative energy and biotechnology.
But where investment trusts also excel is in giving investors the chance to invest across many different stockmarkets around the world. Trusts which invest globally provide investors with a one-stop shop that can be used as a long term core investment. These trusts are equally useful for building up nest eggs for children as they are for building up your retirement savings.
And if you need an income – investment trusts have a long and distinguished record of paying out rising dividends year after year, unlike savings accounts on which interest rates are continually going up and down.
How investment trusts work
Investment trusts are similar to unit trusts, or Oeics (pronounce ‘oiks’) or open ended investment companies in that they are both collective investments and both invest in shares and other assets with the aim of providing good returns for investors.
But there are some significant differences between them. Investment trusts are set up as companies with a fixed number of shares (referred to as being closed ended), while unit trust or oeics are open ended funds which can issue or buy back shares, depending on investor demand.
As investment trusts are companies they have independent boards of directors. The board’s main job is to appoint the investment managers, monitor performance and to safeguard the interests of the shareholders.
If the investment managers’ performance is not up to scratch, the board can dismiss them and appoint a new set of managers to take over and today’s boards are not shy about flexing their muscles.
In recent years, several boards have switched trusts to different investment managers including Edinburgh Investment Trust which was moved to Fidelity, Scottish American which was moved to Baillie Gifford, and Witan which has adopted a multi-manager approach.
Unit trusts and Oeics are owned by their investment management companies, which tend to be somewhat less critical about their own performance.
Investment trust returns
As with any other company, the value of your holding in an investment trust depends on the share price - it is that simple.
What complicates matters somewhat is that an investment trust’s share price does not necessarily reflect the value of its investments. What a share is worth in investment terms is called the ‘net asset value’ or NAV. But the share price is driven by the level of demand for its shares – a classic case of price being dictated by supply and demand.
When the share price is lower than the NAV, a trust is said to be trading at a discount. This is normally expressed as a percentage. So if the price is 95p and the NAV is 100p, the trust is said to be trading on a discount of 5 per cent. When the share price is higher than the NAV, the trust is said to be trading at a premium.
Do discounts matter? Buying investment shares at a discount can be quite an advantage. If the discount narrows between the time you buy and sell your shares, this will add to your return.
In other words, if the investments in a trust rise by 10 per cent, the NAV in the example above will increase to 110p. If at the same time the discount narrows and the share price rises to 106.7p, it means your return is 12 per cent, so it is higher than the investment return of 10 per cent.
But discounts can work against you. If the discount widens, say from 5 per cent to 10 per cent, your returns will be reduced. Widening discounts are caused by there being more sellers than buyers of the shares. Fortunately, nowadays, trust boards are able to reduce these discount movements by buying in some of the trust’s shares themselves.
Another feature of investment trusts that can affect your returns is the ability of trusts to borrow money so that the managers can buy more shares. This process is known as ‘gearing.’
Managers borrow money when they are confident that the returns they can get by investing this money will be higher than the cost of the borrowing. If the managers are right your returns will be enhanced. If not, gearing can act as a drag on performance.
Charges
One of the advantages of investment trusts are their low annual management charges. The latest survey for the Association of Investment Companies (AIC) found that 25 per cent of trusts have total expense ratios of under 1 per cent, while 55 per cent have total charges of under 1.5 per cent. By contrast, the most recent survey of unit trusts and oeics found their average annual charge is 1.62 per cent.
Nowadays, some investment trusts also have performance fees as an extra incentive to their investment managers to outperform their performance benchmarks.
Different types of share
Most investment trusts issue only one type of share. These are ‘ordinary’ shares which benefit from both the income generated by the trust’s underlying investments and any capital growth.
Some investment trusts, known as ‘split capital’ trusts, are set up for a fixed term and have more than one type of share, with the returns on each type of share being different. The main shares in split capital trusts are:
- zero dividend preference shares – shares which get no income, but are entitled to a fixed percentage of capital growth at the end of the trust’s lifeincome shares - shares which are entitled to all of the income from the trust’s investments and a fixed repayment value;
- capital shares – shares which receive no income, but are entitled to all the capital growth on the investments when the trust winds up.
The complexity of split capital trusts makes them a higher risk investment than ‘conventional’ investment trusts and in the early years of this decade a number of these trusts collapsed spectacularly causing huge losses to some investors which is why they are best left to professional investors.
How do I buy an investment trust?
There are three main ways of buying investment trusts and whichever you choose you will have to pay government stamp duty of 0.5 per cent:
- direct from the managers – most management groups offer their own low cost investment schemes. Typical investment charges range from 0.2 per to 1 per cent. Some groups offer free purchases, including Aberdeen Asset Managers, Baillie Gifford and Schroder. Minimum lump sum investments normally start at £250. If you want to make regular savings, managers’ schemes are especially attractive. Minimum monthly savings typically start at £30 or £50. Individual Savings Accounts (ISAs) are also available.
- through a stockbroker – buying investment trusts through a stockbroker is worth considering if you need advice on which trusts to buy or you want your money to be invested immediately. The cost of buying through a stockbroker varies significantly. Some charge flat fees of as little as £12.50 per trade. But if you want advice, you will have to pay more.
- through a trust ‘supermarket’ - if you want access to wide variety of trusts and the ability to switch around between them, it is a good idea to invest via a ‘supermarket’ such as those offered by Alliance Trust Savings, Hargreaves Lansdown and Henderson Global Investors. Charges vary.
How do I check the performance of investment trusts?
If you want to check the price of your investment trust shares, you will find them listed under ‘investment companies’ in the share price pages in the business section of newspapers, such as the Financial Times, The Times and The Daily Telegraph, or online at www.Trustnet.com or www.Hemscott.com.
If you want to find out the performance of your trusts and how they compare with other trusts of the same type, various magazines are available such as Investment Trusts Magazine, while online sources include www.theAIC.com and www.Trustnet.com.
How do investment trusts compare with unit trusts and Oeics?
Investment trusts, unit trusts and oeics (open ended investment companies) are alike in many ways. They pool investors’ money into large portfolios which they invest in the stockmarket or other assets to achieve the best returns. So which succeeds best?
Average performance figures show investment trusts have consistently outshone unit trusts and oeics over the last ten years.
1 year 3 years 5 years 10 years Unit trust/Oeic av. performance £110 £148 £189 £182 Investment trust av. performance £115 £183 £272 £247 Source: AIC and Morningstar figures show the average value of £100 invested over various periods to 1 October 2007; unit trust/oeic performance on bid-to-bid price basis, with net income reinvested, investment trust performance on mid-price basis with net income reinvested.
Various reasons are put forward for the better performance of investment trusts. One is that investment trusts benefit because they are closed-ended, so they do not have to sell any of their investments if investors want their money back. Unit trusts and Oeic managers, on the other hand, can be forced into selling some of their best investments if investors want to withdraw their money.
A more likely reason over the last decade is the use of gearing by investment trust managers. By being able to borrow money to invest they did particularly well when stockmarkets began rising after the 2000- 2003 bear market.
A selection of leading investment trust companies
The largest and most popular investment trusts tend to be the global growth trusts. They are seen as good long term investments as they give you exposure to all of the world’s main stockmarkets including the UK. Another popular category of trusts are those which pay out a rising income year after year.
Here are some of the leading trusts:
Alliance: This trust was founded in 1888 and is the largest global growth trust with £3bn of assets. It is seen as a solid core holding, with one of the lowest expense ratios of just 0.41 per cent per year. It is self managed, which means it employs its own investment managers led by Katherine Garrett-Cox. Its investment policy has traditionally been conservative and it has only recently started to use gearing. It is typically over 50 per cent invested in the UK. It gets additional income from its subsidiary Alliance Trust Savings.
Bankers – set up in 1888 by a group of bankers, this trust is now managed by Alex Crooke at Henderson Global Investors. It invests in equities globally, but has a large core holding in UK. It is attractive to income investors, as its one of its main aims is to provide an income that grows at a faster rate than inflation. It currently has one of the highest yields in the global growth sector and has increased its dividend every year for the last 38 years.
British Empire Securities & General – this trust was originally formed in 1889 to invest in diamond and gold mining interests in South Africa. It now invests globally, offering greater diversification than many other global trusts. Besides shares, it also invests in property, private equity and hedge funds, mainly through buying undervalued investment companies.
Caledonia – Caledonia has only officially been an investment trust since 2003, having previously looked after the investments of the wealthy Cayzer family who still own a third of the trust’s shares.
Its investment managers have a focused, ‘hands-on’ approach, taking board positions in many of the companies they invest in. The trust’s top ten holdings represent more than 50 per cent of its portfolio. It has the largest income reserves of any investment trust which will enable it to pay increasing dividends for many years to come.
City of London – this company was originally called the City of London Brewery company. It finally dropped its brewing interests in the 1960s and is run by Henderson Global Investors. The manager, Job Curtis, has a conservative investment style and invests predominantly in larger UK companies. This trust is particularly attractive to income seekers. In 2007 it increased its dividend for the 41st consecutive year, the longest record of any investment trust.
Monks - this is one of four global investment trusts run by Baillie Gifford which has established a very good reputation for managing global trusts. Monks has a relatively low exposure to the UK and is prepared to move freely between markets and adjust its investment style as opportunities arise. Capital growth takes priority over income.
Foreign & Colonial – this is the UK’s oldest trust and is the second largest. It is seen as a core long term holding, particularly suitable for children’s savings. It invests around 40 per cent in the UK and 60 per cent elsewhere. Managed by Jeremy Tigue, with the support of an 85 strong team of fund managers, it is highly diversified and holds more than 600 shares in 35 countries around the globe.
Law Debenture – founded in 1889, this trust is managed by James Henderson of Henderson Global Investors. Seen as a good choice for investors seeking a mixture of income and long term capital growth, this is regarded as more of a “UK plus” than a full global trust as it maintains a high UK content of around 60 per cent. In addition to its investment portfolio it also runs a trustee business which contributes significantly to its profits.
RIT Capital Partners – this is a global trust which invests not just in equities but also has exposure to fixed interest securities, hedge funds and property. It holds unquoted, as well as listed companies. Lord Rothschild owns around 14 per cent of the shares and has a hands-on role in running the trust alongside its highly regarded manager, Duncan Budge. It is seen as more aggressively managed than many global trusts.
Templeton Emerging Markets – this trust is seen as a core holding for investors who want exposure to some of the world’s fastest growing economies, such as China, Brazil and India. It is run by one of the most experienced emerging markets teams in the investment world, led by Mark Mobius. It has a relatively concentrated portfolio with its top ten holdings representing over 40 per cent of its portfolio.
Why does my financial adviser never mention investment trusts?
It is widely acknowledged that the main reason financial advisers do not recommend investment trusts is because they do not receive commission for doing so. With unit trust and Oeics, on the other hand, advisers receive both initial and annual commissions. So unless you are prepared to pay a fee, financial advisers will rarely mention investment trusts. Alternatively, you can buy investment trusts yourself, as described earlier.
Useful links:
www.theaic.co.uk- the website of the Association of Investment Companies. It provides news, contact details and performance figures for trusts which are AIC members; www.trustnet.com – provides details and performance figures of trusts which subscribe to its service; www.hemscott.com – provides basic information on each trust.
Last edited October 2007
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Nothing in this guide is, or shall be deemed to constitute, financial or other advice or a recommendation to purchase any product or service.