ALEX DENNY and CLAIRE DWYER give a millennial perspective on the attraction of investment trusts for a younger generation of investors.

Why might investment trusts appeal to younger investors?

Alex Denny: I’m flattered to have been described as a millennial. I suppose I just about qualify having been born in the early 1980s! There is actually another term that has been created for people around my age which is ‘Xennial’; lost somewhere between Generation X and those who don’t remember a world before the internet. I like to think that this helps me to identify well with both older and younger groups.

Knowing what I know now, it is obvious to me that investment trusts should appeal to younger investors for the same reasons that they appeal to older ones. Put simply, they are an excellent vehicle for investing in assets (of almost any type) for the medium or long term. Younger investors obviously have longer investment horizons than their parents. They have longer until they retire (and, dare I say it, die). It follows that they have most to gain from the excess returns which investment trusts can make over many other types of investment funds across economic cycles.

The challenge with younger investors often isn’t about persuading them about the merits of investing in investment trusts, but persuading them about the merits of investing at all. Many young professionals in their 20s or 30s find themselves heavily in debt. Student loans, mortgages and credit card debt mean that many live their lives with liabilities which far exceed their assets.

Being ‘cash poor’ is a difficult position from which to begin investing and, in truth, for those with expensive unsecured debt such as credit cards, it is very sensible to pay these debts down before beginning to invest in risk assets. An average APR of 23.1%* for a credit card is hard to beat consistently with any investment.

However, once those expensive debts have been paid down, there is clear evidence that younger people are not putting enough of their income aside for their future needs. One recent report suggests that a millennial would need to have accumulated the equivalent of at least £260,000 at retirement (rising to £445,000 for those who don’t own a property) to enjoy even a basic income thereafter.†

Of course, whether in debt or not, with auto-enrolment in a pension scheme now mandatory, all young professionals are doing some compulsory saving. Their pension pot is bound to build up over time as their employers contribute to it. There is a wealth of academic evidence that on average and over the longer term investment trusts produce returns that outstrip bank interest rates, inflation, stock market indices and many other types of fund.‡

That has certainly been the case over the last ten years. An investment of £10,000 into FIDELITY SPECIAL VALUES PLC in 2008 would have been worth £36,000 ten years later. That is equivalent to a return of 13.5% per annum and compares to the £21,000 you would have had from investing in an FTSE All-Share index fund. £10,000 grown in line with RPI inflation meanwhile would be just £12,300 today.§ With an ever-growing need for people to save for their own futures, investing in a vehicle with such a long track record of success would seem an obvious choice for the younger investor.

Claire Dwyer: While the investment trust has a long and distinguished pedigree as a vehicle, the portfolio themes that managers are capitalising on as we edge through the 21st century are distinctly modern. It’s hard not to think that they should be capturing the imaginations of millennial investors more than they are. If the electric lightbulb was once the miracle, it’s now surely the internet and its underlying algorithms. Around the world consumption is shifting towards digital, cashless and mobile transactions, especially in Asia where app-savvy millennials are shaping the future direction of the continent’s economies.

Dale Nicholls, who runs FIDELITY CHINA SPECIAL SITUATIONS PLC, likes to point out that the country’s transition to a consumption-led economy and a rising middle class is throwing up a host of new investment opportunities. Disposable income per capita in China has more than doubled in the past decade, while retail sales continue to rise at a double-digit pace.

In a recent catch-up Dale mentioned his interest in a couple of Chinese companies experimenting with innovative, lucrative and tech-enabled models like live-streaming, where consumers of online content can purchase virtual gifts for the online hosts they follow. Many younger investors will be experiencing these sorts of developments first hand. I’ve been sent a virtual pet monkey myself.

China’s Jiulinghou, or ‘post-90s’ generation, born in the 1990s, now number more than 200m. They’ll have grown up in one-child households in the digital era and are now in their late teens to early 30s. For this generation the rate of economic growth has been eye-watering and compared with previous generations this cohort has greater disposable income at a younger age and a marked propensity for online spending.

The point I am making is that the millennial generation has a chance not only to enjoy the wonders of the internet age in their daily lives, but also to profit from investing in the changes that they and their counterparts on the other side of the world are helping to make to the way that society operates and goes about its business. Doing well by doing good, if you want to philosophise about it.

Do you have advice to younger investors when picking an investment trust?

AD: My first piece of advice to younger investors is simply ‘make sure you pick something’. Don’t just leave cash in the bank and watch it lose its value in real terms. When saving for retirement, I would echo Steve Webb, the former pensions minister, who came up with a simple acronym. ‘SUM’: Start as quickly as you can. Up your contributions when you get a pay-rise. Max out on what your employer will give you by putting more in yourself.

Of course, pensions aren’t the only place that young people can save or invest. The choices available in most defined-contribution pension plans are woefully thin. So my next piece of advice is to consider where, or what tax wrapper, you hold your money in. If it is a pension you’re after and you have accumulated a decent size of assets already, then a self-invested personal pension (SIPP) may provide you with a better choice, including the ability to put your money into investment trusts.

If you think you may need the money before retirement (to buy a house, a car, or start a family etc.) then an individual savings account (or ISA) is probably the best tax-efficient choice. The fact that you won’t have to pay any tax on the income or capital gains you make is an extraordinarily valuable gift from the government – one of the few that directly benefits young people. The more years you are able to put money into an ISA, the more valuable that benefit becomes.

While you may envy the fact that your parents have gained so much from being able to buy a house when they were young and watch its value soar, the ability to invest up to £20,000 a year without having to pay any tax on the income or capital gains is potentially just as golden an opportunity for you and your contemporaries – and certainly something your parents would have loved to have been able to do. It is a shame that this is not as widely appreciated as it should be.

If you have made this choice and are looking at investment trusts, I would start with a core portfolio option, a trust that diversifies broadly across the investment spectrum. Within the UK, a UK-focused investment trust makes sense, as would a global or European trust. This can then be added to over time with trusts that invest in other regions or asset classes to add diversification to your portfolio.

My personal view is that younger investors with long time horizons should focus on potentially riskier asset classes (such as equities) which have higher growth potential over market cycles. Often, the media focus too heavily on dividend yields and the income which can be earned from an investment. This may be great for older investors, but is often a distraction for investors with multi-decade time horizons. Yes, you will have to learn that shares prices can rise and fall from year to year, but you have so many years of saving ahead of you that you can afford to sit through the down years and give your money the time to let the gains accumulate.

Research and then choose a manager with a process that you can understand and that feels intuitive. There are great tools and lots of information about the range of investment trusts from online platforms, such as Fidelity’s own or Hargreaves Lansdown and others. Websites such as Morningstar and Trustnet also have tons of searchable and sortable data. Most also offer apps that allow you to keep track of the markets and your favourite funds on your smartphone.

As a millennial, thanks to the internet you have the huge advantage of not just having better information than most professional investors had access to 30 years ago, but also the priceless advantage of knowing how to find and manipulate online data sources without difficulty. You can certainly use your familiarity with the digital world to make the most of your finances.

Lastly, I would recommend that younger investors (and all investors generally) keep regular but not-too-frequent tabs on the progress of their investments. Markets can and will fall as well as rise, and the temptation to change an investment just because it has fallen in value can sometimes lead investors to make irrational choices. What you want to know is that your investment manager is sticking to his or her process, that it still makes sense, and that you have faith in them over the longer term. Everything else is just noise.

How are developments in platform technology likely to impact who is buying investment trusts and how they go about it?

AD: Basically it is getting cheaper and easier! Over the past few years, most investment platforms – which are essentially websites that allow you to research, buy and store all your investments in one place – have been improving the way they offer access to investments listed on the stock exchange. Real-time dealing allows investors to see and choose the price at which they invest, monitoring the level of demand for shares and whether they are trading at a premium or discount.

Importantly, pretty much all platforms these days allow low-cost regular investments (monthly or quarterly etc.) as well as dividend reinvestment plans. This means that investors can benefit from investing on a regular and steady basis, which averages out short-term swings in price and break downs their investment into manageable chunks that can be timed to coincide with their salary. This is all light years ahead of the cumbersome paper-based process which used to absorb hours of time and effort for earlier generations.

Increased automation has led to faster and more accurate dealing, while reducing the costs, which can often be simple one-off cash-sum fees or maybe a set percentage of the whole deal value. The Association of Investment Companies (AIC) has recently launched a useful fees-comparison tool which allows you to work out which platform would be the most cost-effective for the size and types of deals that you would like to place. It may make sense to start out with one of the cheaper options and then trade up as your portfolio increases in size and sophistication.

How important is socially responsible investing to younger investors?

CD: I certainly think it’s fair to say that sustainable – or socially responsible – investing is of special interest to younger investors. A recent paper on the subject by Ernst & Young suggests that millennial investors are nearly twice as likely as those in other age groups to invest in companies that target specific social or environmental outcomes. This is a good argument for active investing – and in particular, the investment trust, where you have not just the fund manager, but the board monitoring the composition of the portfolio.

Financial data such as accounting statements often do not provide the level or type of information required to make sure environmental, social and governance (ESG) issues are being appropriately considered. The early iterations of ESG investment strategies generally took quite a blunt approach to sustainable investing – simply excluding ‘sin’ sectors like gambling and tobacco, or by attempting to deliver a particular benefit or impact.

More recent approaches are more nuanced and sophisticated, often making quantitative assessments of key ESG metrics. Our view at Fidelity is that high standards of corporate responsibility make good business sense and have the potential to protect and enhance investment returns and to this end we have a dedicated team of global ESG specialists to provide guidance. The more money that flows into socially responsible investment vehicles, the more influence they will be able to bring to bear on how business operates and the more power to change the world they will acquire.

And changes to corporate governance?

CD: Much ink has been spilt on the subject of board diversity, both at the company level and the investment trust itself. The UK’s public companies will need to significantly up the number of women appointed to their boards in the next couple of years if they are to meet government-backed targets. While progress has been made, its pace has arguably been too slow, and this is an aspect of governance that portfolio managers and boards alike are monitoring closely for developments.

The global financial crisis exposed serious deficiencies in corporate governance and I think the fact that this occurred just as many millennials were entering the workplace is significant. Ten years on there’s a greater demand for transparency and accountability. Another reason I think an investment trust should appeal to this group of investors is the ability for them to make their voice heard as shareholders. It’s always encouraging to hear new ideas and have a healthy degree of challenge at annual general meetings. With open-ended funds that potential doesn’t exist in the same way.

What are the implications of the evolving pension market for millennial investors?

AD: At industry level, we are seeing a sea-change in how pension money is invested. It is unfortunately not necessarily to the benefit of millennials. Not only are millennials faced with a complex regulatory maze of annual and lifetime allowances (the former of which is pretty generous and the latter unjustifiably limiting), they are of course widely denied access to the guarantees of the defined-benefit schemes available to their forebears.

It’s easy to see why the defined-benefit pension has had to change. One need only look at the recent collapse of Carillion, the giant outsourcing company, to see the risks that an underfunded pension scheme poses to the benefits of its members. It is not hard to argue that a defined-contribution scheme, which offers no guaranteed future benefits, but is fully independent from the fortunes of the sponsor employer, may provide a better outcome than a defined-benefit scheme which fails all of its members.

However, the shift from defined-benefit to defined-contribution schemes has had some unintended consequences. In the past investment managers of defined-benefit schemes were given the task of taking risk-based asset allocation decisions to help achieve their long-term investment targets. To that end they often turned to investment trusts to provide enhanced investment returns or diversification into illiquid asset classes.

Defined-contribution pension schemes, by contrast, tend to focus much more on cost than on value, and the trustees are limited in the range of options they can provide. To the best of my knowledge, there are no defined-contribution schemes in the UK which offer members access to investment trusts. If you want to have those wider investment options, investors are effectively forced to transfer to a SIPP. That is something for millennials to agitate about at your workplace!

* Source: Which, June 2018: www.which.co.uk/news/2018/06/credit-card-interest-rates-on-therise- how-to-find-the-best-deals

† Source: www.theguardian.com/money/2018/may/16/average-person-will-need-260000-forretirement-says-report

‡ Source: AIC and CASS Business School.

§ Source: FE Trustnet – to 31/08/2018.

 

ALEX DENNY is head of investment trusts at Fidelity and CLAIRE DWYER is an associate director in the same team.