In spite of the mystique that surrounds them, the investment trust concept is very simple. Just like unit trusts, investment trusts are collective investment funds run by expert managers that pool together investors’ money and enable them to invest in a broad range of assets in a cost-effective way.
But while they share these characteristics with other forms of collective investment, they certainly haven’t shared the limelight. Simon Cordery, head of business development for investment trusts at BMO Global Asset Management, says there are number of reasons for this. “Unlike unit trusts, investment trusts are public limited companies so, although you can promote the savings plans, you can’t advertise the investment trust itself.” These differences also mean they have long been shunned by independent financial advisers (IFAs).
As well as being traded on the stock market, the absence of any commission meant
they didn’t feature on many advisers’ list of recommendations. However Mr Cordery says this is changing: “The Retail Distribution Review, which replaced commission with fees, has helped and we’re now seeing investment trusts increasingly being included on platforms alongside other collective investments.”
Another reason they haven’t had the exposure of their unit trust peers is that they are a little more complex. The key difference is that they’re closed ended. This means that while an open-ended fund, such as a unit trust, will simply issue more and more units to meet demand, there will always be a finite number of investment trust shares available.
As a result, supply and demand will also affect the price of the investment trust. So when an investment trust is in demand, perhaps as a result of strong performance, the price will rise and you will need to pay more than its so-called net asset value to buy it. This is known as trading at a premium. Conversely, when demand drops, the share price will be lower than the value of the underlying assets allowing you to buy it at a discount.
As an investment trust’s price can move up and down along the premium discount scale, it adds another dimension to the performance. James de Sausmarez, director and head of investment trusts at Henderson Global Investors, explains: “It does add some risk regarding when you buy or sell, but if you intend to hold them for the long term this should be minimal.”
However, while this close-ended structure adds to the complexity of investment trusts, its advantage is that it can give the fund manager greater control of the underlying investments.
Mr Cordery explains: “A unit trust manager may have to sell assets if hit by a stream of investors selling their units, with the best performing assets the easiest to sell in times of stress. An investment trust manager doesn’t need to sell anything and the discount will simply increase.”
Another feature of investment trusts is their ability to borrow to invest. In a rising market this will magnify performance although the downside is that it will increase losses when markets are falling.
Although this can sound alarmingly similar to high-risk hedge funds, Andrew Bell, chief executive of Witan, says many investment trusts have much tighter rules in place to control the risk. “Most will publish their policy, setting out how much they can borrow,” he explains. “For example, we can borrow up to 20% of the trust’s value, but in reality we would only borrow up to 15% to allow for any market movements.”
A steady income stream
What can also make investment trusts a winner if you’re in retirement is the ability of many of them to produce a steady income stream. This feature is enhanced by the rules surrounding them as Ben Willis, head of research at Whitechurch Securities, explains: “Unlike unit trusts which must distribute all of their income in the year they receive it, investment trusts are able to hold back up to 15% of the dividends generated by the underlying portfolio. This can then be used to supplement dividends in later years, helping to smooth out income payments.”A good example of this occurred in 2009.
“Dividends from traditional sources such as the banks dried up in 2009, leaving some unit trusts with very little to pay their investors,” says Neil Mumford, chartered financial planner at Milestone Wealth Management. “Conversely, investment trust managers were able to dip into their reserves to ensure their investors didn’t miss out.”
Although there is no guarantee that this reserve will always be able to cover income demands, many investment trusts have successfully increased the amount they pay out year after year.
This is highlighted in the Association of Investment Companies’ list of dividend heroes (see at the bottom of this page), a group of trusts where the dividend has consistently increased for 20 years or more.
Which investment trust sectors are most suited to your needs will depend on your appetite for risk and the length of time you’re happy to leave your money invested.
If you’re still focused on pumping up your pension, Mr Willis recommends the Scottish Mortgage Investment Trust. “The management team of this global equity trust focuses on being strictly ‘buy and hold’ investors which means short-term underperformance may occur,” he says. “However, over the long term it has delivered excellent returns as its investment ideas come to fruition.”
Once in retirement, income becomes increasingly important. Mr Willis recommends picking trusts that generate income, either with a UK or global approach. For UK income, he recommends the Lowland Investment Trust, which seeks income opportunities across mid and large cap companies, and the City of London Investment Trust, which he describes as a good, solid trust with low charges.
On the global front, he plumps for Witan Investment Trust, which adopts a multi-manager approach to investing in global equities. “It has an exemplary dividend growth record, increasing the dividend every year for nearly 40 years, as well as careful control on annual fees,” adds Mr Willis. “The average overall annual fee comes in under 1%, comparing very favourably with equivalent multi-manager unit trusts where fees can be over 2%.”
Switching into income generating trusts at retirement is one option but Mr Mumford suggests going for income before retirement too. He explains: “Rather than take the income, reinvest it. Most platforms will allow you to do this and it will enable you to buy more shares, which with capital growth and further dividends, will help your investment grow.”
As a result, he recommends keeping it simple and picking one of the large trusts with either a UK or global mandate. “Go for global trusts such as Scottish American or Murray International for a higher yield or Witan or Bankers for a lower yield [and less risk],” he says. “For UK exposure, we recommend Perpetual Income and Growth, City of London and Troy Income and Growth.”
He also throws a couple of trusts – Aberdeen Asian Income and JP Morgan Emerging Markets – into the mix if you want to take more risk. “The risk is probably too high for most people in retirement but these are well-managed trusts that could be worth considering when you’re building your savings,” he adds.
For a slightly different approach, another trust that proves popular in the retirement market according to Gary Smith, associate director of financial planning at Tilney Bestinvest, is the Battle Against Cancer Investment Trust, or Bacit for short. “This produces some income but is more of a long-term play,” he explains. “However, what makes it particularly popular is the philanthropic angle. The trust makes an annual donation to charity and is also managed by very experienced managers who waive their fees.”
If the investment trust concept suits your investment objectives and risk profile, it’s relatively simple to add them to your portfolio. Mr Willis says that, although the traditional way to do this was through a stockbroker, it has become a lot easier. “You can now also access investment trusts through a fund platform or by contacting the fund groups that distribute them,” he explains.
The cost of buying and selling investment trusts varies. Generally, you will be looking at a dealing charge, typically of around £12 when you buy or sell, plus stamp duty of 0.5% on the purchase. But do shop around and compare deals as charges can depend on whether you invest regularly and whether you hold your investments in a tax-efficient wrapper such as an Isa or pension.
“I’d always pick an investment trust over a unit trust”
Archie Scott, aged 59, from Wokingham in Berkshire (pictured above), thanks his career for introducing him to investment trusts. “During my chartered accountancy training in Edinburgh, I was involved in the auditing of some investment trusts. This gave me an insight into how they operated and, as I liked what I saw, I decided to invest in a couple of them.”
Among his first investments, and one he still holds in his portfolio, is Baillie Gifford Shin Nippon, a trust which invests in small Japanese companies. “I applied for an initial holding of shares when it launched back in 1985 and, although it’s been a bit of a rollercoaster ride along the way, the shares have risen from 50p to around £6 today,” he says.
Over the years, he has built up his retirement savings investing in unit trusts as well as investment trusts, and holding them in tax-efficient Isa and pension wrappers wherever possible. “If all things are equal, I’d always pick an investment trust over a unit trust,” he says.
“They have lower and more transparent charges and their ability to borrow can mean better performance in a rising market.”
Archie is now considering starting to tap into his investment portfolio. “For the past 30 years, I’ve reinvested the dividends to enable my investments to grow faster,” he says, “but these dividends may soon form part of my income in retirement.”
Dividend heroes: the trusts that keep on giving
Inflationary pressures means that a rising income is essential to maintain your standard of living in retirement. As this is something that many investment companies aim to do, the Association of Investment Companies (AIC) has compiled its list of dividend heroes, identifying all of those that have increased their dividends every year for at least 20 years. Of the 20 that made the grade, these are the 10 with the longest track records.
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An investment trust for the grandkids
Investment trusts can also work well if you’re looking to invest for your grandchildren. Andrew Bell, chief executive of Witan, explains: “Investment trusts have a well-diversified portfolio, helping to spread risk. In addition, the transaction charges tend to be lower than on unit trusts, which can make a significant difference to the return over the long term.”
Several of the investment trust companies offer savings schemes specifically for children. These allow you to make a minimum lump sum of between £50 and £500 or make regular payments from as little as £25 a month.
It’s also possible to take out a Junior Isa that invests in investment trusts. These allow you to pay in up to £4,080 in 2016/17 without paying tax on the gains. Minimum investments start from as little as £50, or £30 a month, and annual charges range from zero on Fidelity’s Junior Isa to £40 on Alliance Trust’s.
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