What does 2013 hold for investment trusts?

Published by Andrew Pitts on 27 November 2012.
Last updated on 02 January 2013

Investment trusts and investment companies are too often ignored by private investors. It's usually for one of two reasons, or both. They are not as 'visible' as funds - most financial advisers do not recommend them to clients and most trusts do not market themselves as aggressively as funds.

But the presence of discounts or premiums - when a trust's share price is either lower or higher than its underlying asset value - is also a factor. The shares of all but a handful of trusts trade in this way, with most trading at discounts to net asset value, or NAV.

Outperfoming funds

But it can be argued that investors who buy trusts for the long term should put the issue of discounts out of their minds. That's because investment trusts, on average, outperform funds, and often by a significant margin, on both share price and NAV.

Alan Brierley, director of investment companies at stockbroker Canaccord Genuity, encapsulates the reasons. "Lower total expense ratios, the ability to focus on managing money rather than be distracted by managing inflows/redemptions, the ability of income funds to use revenue reserves to smooth dividend payouts, the potential for NAV enhancements through gearing, buybacks and share issuance give trusts strong competitive advantages."

Brierley revels in pointing out the performance disparities and regularly highlights them in annual comparisons. The most recent, to the end of 2011, analysed average performance of funds and trusts over 10 years in popular, comparable sectors. It made uncomfortable reading for fund fans but was a compelling story for trust aficionados, as well as for those who ignore them.

Global trusts

The widest disparity was between global growth trusts and funds. On an annualised basis, trusts outperformed by an average 4.4%; in the Global Growth & Income sectors it was 4%; 3.9% extra each year among Asia Pacific ex-Japan trusts; 3.7% in Global Emerging Markets; and 2.2% in Europe ex-UK.

Trusts that focus on mainstream UK Shares and UK Equity Income outperformed by a still-healthy 2.2% and 1.9% respectively. Only in Japan did trusts underperform funds - by 0.4% a year.

Not only that, trusts on average beat the relevant benchmarks except in North America and Japan, whereas funds on average failed to beat any of them. The figures for trusts are based on NAV total return, not the share price total return that investors care most about. But that brings me back to the issue of discounts: they should not be of much concern to the longer-term investor.

Trust discounts are a reflection of investor opinion: either the trust or its sector is out of favour.

If the individual trust is underperforming, its board of directors will be pressured by shareholders to fix it via share buybacks, changing the investment manager, or a corporate action such as wind-up or takeover.

If it's the sector that is underperforming, then 10 years is an adequate period for market sentiment to turn, something that also applies to both funds and trusts.

Structural advantages

The structural advantages that investment trusts have over funds should, over time and with a fair wind, outweigh concerns about trust discounts widening. The caveat is when investors back trusts quoted on significant premiums.

Here the danger is that the trust's strategy or the sector loses favour with investors. That will likely hit popular income-focused trusts currently trading on significant premiums when expectations of interest rate rises start to gain traction.

And what of the financial advisers who have traditionally eschewed trusts?

Come January they are more likely to consider recommending them to clients, because the commission bias that swayed them towards funds will be outlawed on any new recommendations they make.

They might also be more inclined to take note of Brierley's annual performance comparison when he updates them early next year. That's something I am anticipating with relish.

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