Investment trusts fight for their future

The Association of Investment Companies (AIC) and its members are fighting for their future. The threat is from the Alternative Investment Fund Managers Directive, which is working its way through the European Union institutions.

Intended to curb the power of hedge funds and private equity funds in its current unamended form, it will prevent investment trusts from issuing new shares or marketing existing shares to retail investors, limit gearing, undermine the authority of trust boards, and could even force trusts to redeem shares on request.

Such changes would be a blow to almost every trust, from the global growth giants such as Foreign & Colonial Investment Trust and Scottish Mortgage - which have offered investors low-cost, well diversified, long-term core portfolios for 100 years or more - to the newer smaller specialists such as BlackRock New Energy or Jupiter Green Investment Trust.

The average investment trust has served investors much better than similarly oriented open-ended investment companies (OEICs) over the past 30 years and more. It would be a big loss to investors if trusts were forced to adopt a similar business model to OEICs.

It would also be a blow to the nooks and crannies of the investment trust world, which offers individual investors opportunities that are not available through OEICs and are impractical as direct investments.

In some cases this is because trusts invest in assets that are too illiquid to be suitable for open-ended vehicles, where investor withdrawals can require the managers to make speedy sales.

In others, it is because they use the investment trust structure to slice and dice returns to suit shareholders with different needs.
Split capital investment trusts exemplify the latter approach. They have been widely reviled because of the difficulties that arose in the 2000-2003 bear market.

However, split capital trusts have been around in various formats for more than 30 years. Many have served investors well through difficult periods.
Warrants and subscription shares can also capitalise on a trust's corporate structure and can be very rewarding for those prepared to accept above-average risks.

Family-controlled trusts use the trust's closed-end structure in an entirely different way, and their bias towards generating positive (or absolute) returns means they are arguably less risky than most of their peers.

Asia-oriented income trusts exploit yet another aspect of the trust structure, namely the ability to smooth dividends by under-distributing dividends in good years so as to be able to draw on reserves in tougher times.

Asset classes that are better suited to trusts than funds range from the ultra-small, such as fledgling shares, to the ultra-long term, such as forestry. Private equity is a different story, as this asset class tends to exaggerate the ups and downs of the quoted equity market.
It will be a great loss to private investors if the EU directive ends up throwing the baby out with the bath water.

This article was originally published in Money Observer - Moneywise's sister publication - in January 2010

Your Comments

I have 30K of F & C investment trust shares, should I be getting in a panic about the forthcoming E.U. legislation?

Hi Graham - as I understand it its probably to early to be getting worried about this just yet. The deadline for the laws to be introduced is this summer but exactly what will be introduced hasn't been finalized yet, and it may be that investment trusts won't be affected

However if this does come to pass then my guess is it will mean higher management charges but we 've got a while to go before that happens.

Stay calm and carry on!