Solid performers reap big rewards
During the market turmoil at the end of 2007, UK investment trusts held their own. Experts say turmoil is just another obstacle on the road to profit.
Investment trusts can offer the possibility of enhanced investment performance and returns for those willing to take a long-term view, thanks to the flexibility and versatility of this investment vehicle.
"By and large, investment trusts tend to outperform unit trusts," says Jim Tennant, head of investment trusts at Gartmore. "This is mainly because they can gear. Over the long-term, markets go up, so if you're geared at the right time through that period, you should be able to get higher performance," he says.
A glance at a comparison of unit trust and investment trust performance confirms this. A £100 lump sum invested in the average investment trust or closed-ended investment company returned £193 over the three years to the end of July 2007, compared with the average unit trust's £151. Over a longer period, the gap widens further. Over 10 years, the average investment trust returns £246 on that £100 investment, compared with the unit trust's £183.
Investment trusts, like other asset classes, have had mixed fortunes in terms of performance over the last decade, however. In the build-up to 2000, the sector enjoyed strong investor appetite, whetted by the technology boom. But when these heady days ended, investment trusts felt the effects of the financial downturn.
This was felt most keenly in the split capital arena, culminating in the split capital mis-selling debacle that peaked in 2002 and tainted the investment trust industry as a whole.
There has been more positive growth in the investment trust world in recent years, helping demonstrate the merits of this asset class. Gavin Haynes, managing director of independent financial adviser Whitechurch Securities, says that five years ago investors had lost faith in stockmarkets, and discounts in investment trusts were particularly wide. Since then, those gaps have narrowed overall.
Long-term investors reap rewards
Jeremy Tigue, fund manager of the Foreign & Colonial (F&C) Investment Trust, points out that, despite the ups and downs, most of those investing for the long-term would have made money over the last decade.
"Even taking into account the severe bear market we endured from 2000 to 2003 - the worst for 30 years - most investors in investment trusts would still have made money over the last 10 years," he says. "They wouldn't have done in Japan and in a few technology funds, but apart from that, broad spreads of investments - in Europe, small companies, large companies, mining, resources and utility funds, for example - would all have done very well over that period."
Figures from the Association of Investment Companies reflect the rising popularity of investment trusts. In December 2000, there were 358 investment companies with total assets of £78.8 billion. The ensuing downturn saw this drop to £47.7 billion by the end of 2002, although by then there were 363 investment companies.
The sector then began to grow again, and in 2007 the industry's assets hit their highest level ever, reaching nearly £100 billion. At the end of July 2007 the UK investment trust sector was worth £95 billion, and 316 investment trusts were in place. The average discount has fluctuated over the years. It averaged 12.3% at the end of 1997 and 12.7% at the end of 2002. It sat at 7.3% at the end of August in 2007.
Gearing increases positivity
"Markets picked up in 2003, and the bull market effectively restarted," says Richard Wallis, deputy head of research and investment at IFA Origen. "Since that point there are areas that have done very, very well and the gearing has just exaggerated that situation."
Wallis says performance in specialist areas has been particularly strong in recent years, while some of the older and more traditional investment trusts, such as the F&C Investment Trust, have lagged. "Some of the returns are still pretty good, but compared with their respective sector averages, they've plodded," he says.
Similarly, Craig Wetton, investment director at IFA firm Chartwell, suggests some "core" investment trusts are sitting at quite large discounts. However, he says many of these larger core trusts have taken a "long, hard look" at how they are managed and started making greater use of mechanisms such as share buy-back to help keep discount levels under control. Some have also revamped their investment style, moving to segregate investment mandates in a bid to boost performance.
The Witan Investment Trust, for example, has moved to bring in sub-managers for specific areas, such as a UK manager for UK investments and a European specialist. These changes are beginning to be reflected in investment trust performance, but some discount levels are still wide, despite managers' best efforts, Wetton says.
The practice of a dishonest salesperson misrepresenting or misleading an investor about the characteristics of a product or service. For example, selling a person with no dependants a whole-of-life policy. There have been notable mis-selling scandals in the past, including endowment policies tied to mortgages, employees persuaded to leave final salary pensions in favour of money purchase pensions (which paid large commissions to salespeople) and payment protection insurance. There is no legal definition of mis-selling; rather the Financial Services Authority (FSA) issues clarifying guidelines and hopes companies comply with them.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
A collective investment vehicle (known in the US as a “mutual” or “pooled” fund) and similar to an Oeic and investment trust in that it manages financial securities on behalf of small investors who, by investing, pool their resources giving combined benefits of diversification and economies of scale. Investors buy “units” in the fund that have a proportional exposure to all the assets in the fund, and are bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets. Like Oeics (but unlike investment trusts) unit trusts and are “open ended” funds, meaning that the size of each fund can vary according to supply and demand of the units form investors. Unit trusts have two prices; the higher “offer” price you pay to invest and the “bid” price, which is the lower price you receive when you sell. The difference between the two prices is commonly known as the bid/offer spread.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
Investors who borrow money they use for investment and use the securities they buy as collateral for the loan are said to be “gearing up” the portfolio (in the US, gearing is referred to as “leveraging”) and widely used by investment trusts. The greater the gearing as a proportion of the overall portfolio, the greater the potential for profit or loss. If markets rise in value, the investor can pay back the loan and retain the profit but if markets fall, the investor may not be able to cover the borrowing and interest costs, and will make a loss. Also used to describe the ratio of a company’s borrowing in relation to its market capitalisation and the gearing ratio measures the extent to which a company is funded by debt. A company with high gearing is more vulnerable to downturns in the business cycle because the company must continue to service its debt regardless of how bad sales are.
A bull market describes a market where the prevailing trend is upward moving or “bullish”. This is a prolonged period in which investment prices rise faster than their historical average. Bull markets are characterised by optimism, investor confidence and expectations that strong results will continue. Bull markets can happen as a result of an economic recovery, an economic boom, or investor irrationality. It is the opposite of a bear market.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
This refers to a market situation in which the prices of securities are falling and widespread pessimism causes the negative sentiment to be self-perpetuating. As investors anticipate losses in a bear market and selling continues, pessimism grows. A bear market should not be confused with a correction, which is a short-term trend of less than two months. A bear market is the opposite of a bull market.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.