Tools of the investment trust
The structure of investment trusts offers some unique benefits to those ready to take advantage of them. An investment trust is a company, so it has a different management structure to other collective investment vehicles, such as unit trusts and open-ended investment companies (OEICs).
Investment trusts have an independent board of directors that meets several times a year to assess how well they are doing. This board has a legal duty to uphold the interests of the shareholders in the trust - its investors. Gavin Haynes, managing director at independent financial adviser Whitechurch Securities, says: "As with all quoted companies, they are required by law to publish their full year results, annual reports and so on, and to hold annual general meetings.
"The key thing is that the board is accountable to the shareholders and therefore management is accountable to the board. If the board believes that the fund manager isn't performing well, they can replace them."
Increased activity from boards
Over the last five to 10 years boards have become more proactive - particularly in the face of arbitragers keen to come in and take over trusts by buying up the shares. "Boards are starting to be more active in implementing management changes, or buy-back schemes," says Haynes.
While this might not sound a big deal to investors, this way of doing things does have advantages, says Adrian Shandley, managing director of Southport-based Premier Wealth Management. He points to the fact that trust managers are largely unaffected by external influences. "If everyone is selling their trust, that's a problem for the unit trust or OEIC manager because he has got to keep ensuring that he's got liquidity to allow people to redeem units."
Daniel Lockyer, a fund manager at investment firm iimia MitonOptimal, says that, because fund managers do not have to deal with inflows and outflows of money from their funds, they can have a lot more conviction in their portfolios. "You can have an unconstrained and more focused portfolio which doesn't get diluted down by inflows."
The ability of investment trusts to use gearing also means that fund managers can increase or decrease exposure to the market by adjusting their borrowing to help make the most of upswings in the market. "That's another valuable tool for the investment trust manager," Lockyer says.
The strategies and styles of management employed by investment trusts can vary considerably, as they do for other collective investments. "The different styles of investment trusts range from 'plain vanilla' - be it UK equity or large global funds - all the way through to some very specialist trusts with more complicated structures,' Gavin Haynes says.
With around 316 investment trusts - not including venture capital trusts - to choose from in the UK, there are specific investment trusts specialising in particular markets or sectors, such as natural resources or property, while others will invest geographically, say in Europe or in emerging markets around the world.
However, Philip Pearson, partner at Southampton-based IFA firm P&P Invest, believes there is much less overall choice in the investment trust world, compared with that of the collective alternatives. But what investment trusts do offer is access to a wider range of asset classes. "Investment trusts have specialist areas for investment that are currently unavailable elsewhere - examples being hedge funds, private equity, traded life policies and tea plantations," Pearson says.
Variations occur in how much risk an investment trust will take on. "Some are managed more aggressively than others," says Jim Tennant, head of investment trusts at Gartmore. "Some boards will want their manager to manage the fund in an aggressive manner, some will want them to be conservatively managed. Investors understand that," he adds.
The amount of gearing employed can vary in line with the manager's approach.
The style of management that an investment trust employs will also vary. For example, Invesco Perpetual's specialist funds distribution director, Andrew Watkins, says its style is driven by fundamental analysis on a bottom-up basis, while others go for a top-down approach, where there is less emphasis on the merits of individual stocks. "We have to believe in the stock, and it has to be at the right price, with the right sort of growth prospects, a robust balance sheet and prospects of decent dividend growth," Watkins says.
Similarly, some will focus on providing capital growth - making the value of your overall investment grow - while others aim to give investors a regular income from their investment, as well as some capital growth. But this is all within one main share class.
Meeting different needs
Meanwhile, some investment trusts offer several different types of share classes. These are generally known as split capital investment trusts and you get different rights - and different levels of risk - depending on which type you have. The idea is to provide different types of share to meet different investor needs, such as zero dividend preference shares, income shares, ordinary income shares and capital shares.
However, caution is needed when investing in this way, as the extra complexity has cast a shadow over the sector in the past. The problems that split capitals ran into are a reminder that investors need to know what they are getting into. Investment trusts are more complicated than unit trusts and OEICs, and carry the risks and opportunities that gearing and discounts in pricing create.
"I strongly suggest that you do thorough research or seek advice before investing," says Pearson. "Without this, you could expose your capital to a higher degree of investment risk than you feel comfortable with."
Open-ended investment companies are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like an investment trust, an Oeic issues shares but, unlike an investment trust which has a fixed number of shares in issue, like a unit trust, the fund manager of an Oeic can create and redeem (buy back and cancel) shares subject to demand, so new shares are created for investors who want to buy and the Oeic buys back shares from investors who want to sell. Also, Oeic pricing is easier to understand than unit trusts as Oeics only have one price to buy or sell (unit trusts have one price to buy the unit and another lower price when selling it back to the fund).
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.
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.
A sophisticated absolute return fund that seeks to make money for its investors regardless of how global markets are performing. To that end, they invest in shares, bonds, currencies and commodities using a raft of investment techniques such as gearing, short selling, derivatives, futures, options and interest rate swaps. Most are based “offshore” and are not regulated by the financial authorities. Although ordinary investors can gain exposure to hedge funds through certain types of investment funds, direct investment is for the wealthy as most funds require potential investors to have liquid assets greater than £150,000m.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
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.
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.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
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.