Investment Trust Hub

For first-time investors in trusts, here is an overview of investment trusts – what they are and how they invest – from editor JONATHAN DAVIS.

What is an investment trust?

Investment trusts, also known as investment companies, are a type of collective investment fund. All types of fund pool the money of a large number of different investors and delegate the investment of their pooled
assets, typically to a professional fund manager. The idea is that this enables shareholders in the trust to spread their risks and benefit from the professional skills and economies of scale available to an investment management firm.

Collective funds have been a simple and popular way for individual investors to invest their savings for many years, and investment trusts have shared in that success. Today more than £180bn of savers’ assets are invested in investment trusts. The first investment trust was launched as long ago as 1868, so they have a long history. Sales of open-ended funds (unit trusts and OEICs) have grown faster, but investment trust performance has generally been superior.

How do investment trusts differ from unit trusts and open-ended funds?

There are several differences. The most important ones are that shares in investment companies are traded on a stock exchange and are overseen by an independent board of directors, like any other listed company. Shareholders have the right to vote at annual general meetings (AGMs) and vote on the re- election of the directors. Trusts can also, unlike open-ended funds, borrow money in order to enhance returns. Whereas the size of a unit trust rises and
falls from day to day, the capital base of an investment trust remains fixed.

What are discounts?

Because shares in investment trusts are traded on a stock exchange, the share price will fluctuate from day to day in response to supply and demand. Sometimes the shares will change hands for less than the net asset value (NAV) of the company. At other times they will change hands for more than the NAV. The difference between the share price and the NAV is calculated as a percentage of the NAV and is called a discount if the share price is below the NAV and a premium if it is above the NAV.

What is gearing?

In investment gearing refers to the ability of an investor to borrow money in an attempt to enhance the returns that flow from his or her investment decisions. If investments rise more rapidly than the cost of the borrowing, this has the effect of producing higher returns. The reverse is also true. Investment trusts typically borrow around 10–20% of their assets, although this figure varies widely from one trust to another.

What are the main advantages of investing in an investment trust?

Because the capital is largely fixed, the managers of an investment trust can buy and sell the trust’s investments when they wish to – instead of having to buy and sell simply because money is flowing in or out of the fund, as unit trust managers are required to do. The ability to gear, or use borrowed money, can also potentially produce better returns. The fact that the board of an investment trust is accountable to the shareholders can also be an advantage.
Another advantage is that investment companies can invest in a much wider range of investments than other types of fund. In fact, they can invest in almost anything. Although many of the largest trusts invest in listed stocks and bonds, more specialist sectors, such as renewable energy projects, debt securities, aircraft leasing and infrastructure projects such as schools, have also become much more popular in recent years. Investment trusts offer fund investors a broader choice, in other words.

And what are the disadvantages?

The two main disadvantages are share price volatility and potential loss of liquidity. Because investment trusts can trade at a discount to the value of their assets, an investor who sells at the wrong moment may not receive the full asset value for his shares at that point. The day-to-day value of the investment can also fluctuate more than an equivalent open-ended fund. In the case of more specialist trusts, it may not always be possible to buy or sell shares in a trust at a good price because of a lack of liquidity in the market. Investors need to make sure they understand these features before investing.

How many trusts are there?

According to the industry trade body, the Association of Investment Companies, there are currently around 400 investment trusts with more than £180bn in assets (as at the end of September 2018). They are split between a number of different sectors. The largest trust has approximately £5bn in assets.

How are they regulated?

All investment companies are regulated by the Financial Conduct Authority. So too are the managers the board appoints to manage the trust’s investments. Investment trusts are also subject to the Listing Rules of the stock exchange on which they are listed. The board of directors is accountable to shareholders and regulators for the performance of the trust and the appointment of the manager.

How do I invest in an investment trust?

There are a number of different ways. You can buy them directly through a stockbroker, or via an online platform. Some larger investment trusts also have monthly savings schemes where you can transfer a fixed sum every month to the company, which then invests it into its shares on your behalf. If you have a financial adviser, or a portfolio manager, they can arrange the investment for you.

What do investment trusts cost?

As with any share, investors in investment trusts will need to pay brokerage commission when buying or selling shares in an investment trust, and also stamp duty on purchases. The managers appointed by the trust’s directors to make its investments charge an annual management fee which is paid automatically, together with dealing and administration costs, out of the trust’s assets. These management fees typically range from as little as 0.3% to 2.0% or more of the trust’s assets.

What are tax wrappers?

Tax wrappers are schemes which allow individual investors, if they comply with the rules set by the government, to avoid tax on part or all of their investments. The two most important tax wrappers are the Individual Savings Account (or ISA) and the Self-Invested Personal Pension (SIPP). The majority of investment trusts can be held in an ISA or SIPP. There are annual limits on the amounts that can be invested each year (currently £20,000 for an ISA). Venture capital trusts (VCTs) are a specialist type of investment trust which also have a number of tax advantages, reflecting their higher risk.

Where can I find more information?

The best place to start is with the website of the Association of Investment Companies (AIC), which has a lot of basic information, as well as performance and other data. The Money Makers website has detailed tables summarising the main features of the most important trusts. Most online broker platforms, such as Hargreaves Lansdown, Fidelity Funds Network and The Share Centre provide factsheets, performance data, charts and other information. Most trusts now have their own websites too.

Independent research sites, such as FE Trustnet, Interactive Investor, Citywire, DigitalLook, Morningstar and periodicals such as the Financial Times, MoneyWeek, Money Observer and Investors Chronicle also regularly provide updates and recommendations on investment trusts. Citywire has a dedicated online investment trust newsletter. Investment Trusts is an independent subscription-only newsletter.

Industry expert ALEX DENNY explains how using investment trust with different styles and objectives can reduce the risk of investing in financial markets.

When it comes to investing, the benefits of diversification are clearly significant. Most investors will be familiar with how spreading your investments across a range of areas can reduce your exposure to single-asset risk. Putting all your investment eggs in one basket can offer extraordinary returns (think Apple in 2003 or Tencent in 2017), but it can also lead to catastrophic losses (Northern Rock in 2008 or Volkswagen in 2015).

Indeed, some investment fads can be so volatile that they can produce incredible returns and losses in quick succession. Bitcoin returned over 1,000% in 2017 and peaked at around $19,000 in December that year but is down more than 50% since then at the time of writing.

Everyone likes to see their money grow, but there is no risk-free way of guaranteeing these enormous returns. Turning £20 into £10,000 is the kind of gamble you might be willing to take. Turning £10,000 at the time of investment into just £5,000 at the time of redemption is exactly the kind of mistake we all like to avoid.

As a general rule, the majority of investors will therefore look to build a core portfolio of diversified mainstream investments and savings, split across the three broad areas: cash, bonds and equities. This core portfolio will be held through bank accounts and, probably, funds.


Source: Fidelity International, August – indicative chart only.

The allocation or balance between these different assets will vary between different people and are clearly dependent on individual objectives and circumstances – what you are saving for, your age, appetite for risk and capacity for loss.

These core asset classes are exactly that – core. They form a central component of how our financial systems and markets work, but as such they may all suffer from related setbacks. For example, an equity investor may feel confident that holding a range of index trackers provides sufficient diversification. However, in today’s global economy, major inflexion points can occur simultaneously across all markets – just see returns over the second half of 2008 or mid-2015 for a painful reminder.

“SOME INVESTMENT FADS CAN BE SO VOLATILE THAT THEY PRODUCE INCREDIBLE RETURNS AND LOSSES IN QUICK SUCCESSION.”


Source: Datasteam,  August . Index performance based on total return in GBP. Past performance is not a guide to the future.

INVESTMENT TRUSTS AND AVOIDING SYSTEMATIC RISK

There are lots of reasons why global equity markets can follow each other; markets are not rational in the short term. Driven by sentiment, a sell-off in one market can often trigger a downturn in another. The trick to avoiding this sort of risk – and achieve genuine diversification – is to access parts of the market which are not well-covered or represented in an existing core portfolio.

Investment trusts are nearly all actively managed and have structural advantages which allow them to avoid these systemic risk pitfalls. Their capital structure – with a fixed number of shares and no flows of cash in or out from investors – allows them to invest in much smaller, illiquid companies which fall outside of mainstream indices (or have negligible correlation to them).

They also have the ability to invest in companies before they are even listed, as well as alternative areas like real estate or long-term infrastructure projects which aren’t well represented in mainstream funds due to liquidity issues.

There are investment trusts which specialise and focus on investing in these kinds of areas – smaller companies trusts, private equity and venture capital trusts, real estate investment trusts – as well as trusts which follow relatively mainstream markets from the core of your portfolio while adding these non-core elements as well.

Take FIDELITY ASIAN VALUES PLC as an example. It is an actively managed investment trust whose manager, Nitin Bajaj, focuses on buying good, well-run businesses, which are undervalued by much of the market. This often entails buying companies that operate in sectors which are very unfashionable – but can still be very profitable and therefore create good investment returns. This contrarian investment style, by its nature, leads the manager towards industries and companies that do not make up a significant proportion of the regional market index.

In fact, at the time of writing, the company has 99.5% its portfolio held in stocks and assets which do not form part of the MSCI AC Asia ex Japan Index, which is most commonly used as a comparator for funds investing in the region. This figure is called ‘active money’ and gives an indication of how much, or how little, a fund or company’s portfolio differs from a typical benchmark tracker.

Source: Datasteam,  September . Index performance based on total return in GBP. Past performance is not a guide to the future.

With a near total lack of stock overlap, it stands to reason that a holding in the company is not closely correlated with the index over the shorter term – though it still benefits from the long-term structural tailwinds which support the region’s growth. It is therefore possible to complement a mainstream equity portfolio with this type of investment to take out the impacts of short-term trends, smoothing returns and improving risk-adjusted returns at a portfolio level (although diluting out some of the additional absolute returns that may be added by active management).

Another example, in developed markets, is the recent launch of BAILLIE GIFFORD US GROWTH TRUST which eschews simple index returns by having authority to invest up to 50% of its portfolio in companies which are not listed at all. Whether you’re looking to gain exposure to specific alternative asset classes or you are attracted to the ability to invest in small or unlisted companies, these examples highlight to good effect the benefits that investment trusts can offer when held as part of a well-diversified portfolio.

ALEX DENNY is the head of investment trusts at Fidelity International. This article does not constitute investment advice and should not be used as the basis of any investment decision. Past performance is not a reliable indicator of future results.

Investment trust expert MAX KING offers advice to private investors on how to benefit from closed-end funds.

A significant proportion of the financial service sector operates on the assumption that savers are neither capable nor willing of looking after their own investments and so need help from the ‘experts’. Inevitably this help and all the regulatory encumbrances that accompany it are costly, eating into investment returns.

There is often a strong bias towards sacrificing returns for what the professionals regard as lower risk, but which is, in reality, only a reduction in short-term price volatility.

People are accustomed to taking significant financial decisions such as buying a property or a car without paying for advice so why do they not take the same view of their investments? Taking the DIY plunge requires confidence and nerve, but it soon becomes much easier. The greatest dangers lie in getting carried away by success or despondent about disappointment, in letting personal emotions get in the way of sensible decisions and in being influenced by people whose job it is to entertain, scare or impress you, but not to make you money.

The best advice for all would-be investors was carved on the lintel of the doorway to the temple of the Delphic oracle thousands of years ago: “Know yourself ”. What works in investment varies from person to person. It takes time, experience and some uncomfortable mistakes to learn the rules which you are best suited to follow.
Long ago I realised that I was happier investing my own money in funds rather than directly in stocks, bonds or private companies, despite the tax advantages of the latter. Many investors successfully combine all three, but investment funds have some distinct advantages so should form at least a significant part of most portfolios.
Firstly, they encompass a broad spread of underlying investments making them less vulnerable to individual stock disasters. Secondly, they are managed by professionals who are better able to keep abreast of corporate developments, their markets and the broader economy. Finally, with the professional manager taking the individual stock decisions, the investor in the fund can leave well alone, just monitoring its performance and keeping an eye out for signs of trouble.

Inevitably, there are costs attached to this, which means that if you pay a wealth manager to invest in funds for you, you are paying twice over. There is little more satisfying than picking a stock market winner based on an insight the professionals have missed – and few more salutary lessons, on the other hand, than seeing the value of an investment wiped out. Investing in funds reduces the incidence of either extreme.

Having decided to invest in funds, your decision to go for investment trusts or other closed-end investment companies rather than unit trusts (now called open- ended investment companies or OEICs) is an easy one. Numerous studies have shown that over all time periods, closed-end funds nearly always outperform comparable open-ended funds in each sub-sector of the market, even when the funds are run side by side by the same manager.

There are several reasons for this: firstly, closed-end funds tend to have lower costs. Secondly, their managers can take advantage of gearing, borrowing for investment when opportunities are attractive and raising cash when they are not. Thirdly, fund managers find it easier to manage a fixed pool of money than a variable one. When an open-ended fund is doing well, new money floods in, forcing the manager to invest even though prices may be unsustainably high. When the market drops, money floods out and managers have to sell into falling prices. The risk of this also constrains the manager’s ability to invest in less liquid but perhaps highly attractive opportunities.

Another major advantage is that closed-end funds are governed by a board of non-executive directors who are independent of the management company. The management company may be more interested in growing funds under management and in keeping fees high than in performance, but the directors won’t be. If the performance is poor, they can negotiate a fee reduction, a change of manager or a move to another investment company. They will issue new shares only if it is to the advantage of all investors but can also buy in shares if they are cheaply priced. Finally, they scrutinise performance, cross-examine the managers and keep them on their toes far more effectively than happens under the internal governance of OEICs.

Of course, there are some excellent open-ended funds while some interesting segments of financial markets are poorly or not at all served by closed-end funds. On the other hand, there are some areas of the market where open-ended funds with daily liquidity simply don’t work because the underlying assets are too illiquid. Examples include funds investing in private equity, property and the fast-growing area of alternative assets.

Alternative assets encompass funds investing in infrastructure, loans, aircraft, alternative energy and a growing list of other tangible or intangible assets. These funds generally offer a high yield, moderate dividend growth and the prospect of some capital appreciation. This makes them attractive relative to cash, corporate or government bonds and their consequent popularity has led to a flood of new issuance in recent years.

After a slow start, equity issuance in 2018 has accelerated but is unlikely to exceed the 2017 record. As last year, little of it is in the conventional equity space. Investors need to be wary of stock issuance whether for new or established funds as it is often opportunistic, driven by current investor fashion and of more benefit to the sponsors and managers than the investors. As shown in recent years by WOODFORD PATIENT CAPITAL and PERSHING SQUARE, the more popular the new issue, the worse the subsequent performance. But wariness should not extend to a full aversion; BAILLIE GIFFORD US has risen 30% since its flotation early in 2018.

Fund flows are far from being one way but good performance and low discounts mean that buybacks and liquidations are diminishing. Funds reach the end of their pre-determined lives, continuation votes are voted down, boards decide that the investment thesis no longer works and so wind up the company, or boards – whether of their own volition or at the instigation of activist shareholders – return capital to investors. In closed-end funds, disappointing performance usually leads to action but in open-ended funds it often leads only to stagnation.

A key indicator of disappointing performance, or merely that the fund’s investment focus is unappreciated or out of fashion, is the appearance of a discount to net asset value in the share price. Clearly, this cannot happen in an open-ended fund but in a closed-end fund it reflects an excess of sellers over buyers and it makes the share price somewhat more volatile than the net asset value.

For existing investors, a widening discount is a problem, at least in the short term, as it constitutes a drag on the share price. For boards, it may represent an opportunity to enhance performance by buying in shares cheaply, and for new investors, an opportunity to buy the shares cheaply. However, investors should regard a sizable discount as enhancing the case for purchase but not the main reason for purchase.

Maybe the fund, the sector or the market is currently unpopular but will soon bounce back, with the discount disappearing again, but maybe the discount reflects structural issues which cannot be easily addressed. Many good investment trusts habitually trade at a premium but are still worth buying, while discounts will not necessarily narrow if performance is good. That said, there is a long-term trend towards narrowing discounts so that the sector average is now only 2%.

Getting access to information and good research is becoming less of a problem for private investors. Reports and accounts, interim reports and monthly fact sheets are usually available on websites and these contain details of past performance. Click the professional investor/financial adviser tab on the website rather than the private individual one as the latter gives access to much less information.

Comparative information on investment companies is available on the AIC website, together with helpful information on them generally and links to research notes. These have usually been sponsored and paid for by the companies so are not independent but they are a good source of information – and it’s in nobody’s interest for the writers of them to be less than honest.

Many funds and management companies go to considerable length and expense in marketing, providing updates from the manager, podcasts, links to media coverage and easy access to statutory information. There is some very good coverage in the financial press – including, I hope, my own modest contributions in MoneyWeek. Finally, it is always worth turning up to annual general meetings, even if you can’t vote in person. These almost invariably include a presentation by the manager and an opportunity to ask questions either in public or face-to- face afterwards.
Time, however, is not necessarily on the investor’s side. Opportunities can be fleeting so there is little time for homework. Waiting for a setback in the share price or the market or for any discount to asset value to widen is nearly always a mug’s game. Remember the response of Nathan Rothschild when asked the secret of his success: “I never buy at the low and I always sell too soon.” Expect the share price to dip after your purchase and be pleasantly surprised if it doesn’t.

As important as picking good funds is putting together a coherent portfolio. This should include core generalist funds as well as specialist thematic funds. It makes sense to invest in technology, smaller companies, emerging markets and so on but not to have too much in any one niche. It’s good to have a reasonable level of income but this usually involves some sacrifice of total return. A bird in the hand is more highly valued than two in the bush but you may prefer the latter.

Investing in cheap trusts on wide discounts or in unpopular, undervalued areas of the market can be lucrative but be careful; ‘reassuringly expensive’ trusts often perform much better than ones that are visibly cheap. Everyone loves a bargain but real value is reflected in long-term prospects while wide discounts reflect serious trouble as often as investor short-sightedness.

The most difficult question of all is when to sell. As Warren Buffett said, “My favourite holding period is forever.” You don’t need to sell or take some profit in good investments unless you need the cash. I still hold the shares I bought on the flotation of WORLDWIDE HEALTHCARE TRUST at launch in 1995, and have only added to the holding along the way. I was sorely tempted to sell out of BLACKROCK WORLD MINING a few years ago but the share price doubled in the next year. I missed selling out of POLAR CAPITAL TECHNOLOGY in 2000, but can’t be sure I would have bought it back lower down.

Many investment sages point out that nobody ever went bust taking a profit. True; they went bust selling winners and reinvesting in losers. Sell if the investment thesis changes or you have made a mistake but don’t assume that the departure of a good manager is your cue for an exit. The directors are not fools and will be rigorously looking for a worthy replacement.

But isn’t the stock market heading for another meltdown? Isn’t this the time to hold cash and wait for the bargains that litter the bottom of a bear market? The Jeremiahs worry that the economic up-cycle and the bull market have continued for longer than normal and must surely die of old age. At the start of 2018, many pundits predicted that the technology sector and the US market would suffer a setback as the rest of the world caught up. In fact, the reverse happened with the technology sector pushing historic US outperformance ever higher.

As always, there are reasons for concern. Monetary policy is being progressively tightened, especially in the US, and bond yields are pushing remorselessly higher. Emerging economies have, at best, hit bumps in the road, at worst are in crisis. Growth in the eurozone has fizzled out and the political tremors are worsening. The UK looks committed to a bungled Brexit.

Against this, the signs of euphoria and complacency which normally mark market peaks are conspicuously absent. Valuations, barely 16 times forward earnings in the US and lower elsewhere, are not stretched by historic standards and look cheap relative to cash or government bonds. There is no sign of the recession which would send earnings tumbling in the US, Europe or almost anywhere else. After the first decade of the new millennium saw two of the four worst equity bear markets in 100 years, caution and nervousness still prevail. A setback, as seen earlier in 2018, is always possible but more than that looks unlikely.

Geopolitical concerns abound but their impact on markets is highly uncertain. Though the long bull market in government bonds is surely over, the constraints on banks that prevent another credit boom and consequent bust look unlikely to be lifted. This should keep inflation and interest rates moderate by historic if not recent standards. Waiting for a better long-term buying opportunity could mean missing years of steady returns with little bank interest to compensate.

Nick Train, manager of FINSBURY GROWTH TRUST, likes to tell investors each year that he is bullish; he points out that markets rise in three years out of four so that is the smart way to bet. Even if next year turns out to be the one in four, don’t panic. Buying at the high is not the biggest mistake an investor can make – selling at the low is. In time, markets recover and setbacks become barely visible interruptions of the long trend upwards.

MAX KING was an investment manager and strategist at Finsbury Asset Management, J O Hambro and Investec Asset Management. He is now an independent writer, with a regular column in MoneyWeek, and an adviser with a special interest in investment companies. He is a non-executive director of three trusts and has a number of pro bono commitments.

MARK DAMPIER, research director at Hargreaves Lansdown, the UK’s largest and most influential online platform, says that investment trusts can make good choices for self-directed private investors.

Although I only own shares in a handful of investment trusts myself, I do sit on the boards of two trusts and have had the chance to observe them from both sides of the fence. In some respects, trusts are an ideal
investment vehicle for the DIY investor. Many of the principles of investing in unit trusts and OEICs apply equally to investment trusts, but it is undeniable that they are slightly more complicated and harder to explain, which can be a deterrent.

Not that it seems to be deterring an increasing number of private investors from taking an interest, if our experience at Hargreaves Lansdown is any indication. Of the one million plus clients who now use our platform, around 150,000 hold at least one investment trust. In many cases these may be holdings that they held before they transferred their assets to us, but we are also seeing an increase in transactions as well. As you might expect, the wealthier and more sophisticated the client, the more likely they are to hold an investment trust.
How investment trusts differ from unit trusts is that they are (a) closed-ended and (b) trade on the stock exchange. This means that to start life they need to raise money through a public offering of shares (an IPO, in technical jargon) and this gives them a fixed amount of starting capital. Unlike unit trusts, which create or cancel units at will, they can’t grow or reduce their capital anything like as easily as a unit trust can, although it has become easier to do so in recent years.(1)

The net asset value of an investment trust generally rises and falls in line with the market and the expertise of the fund manager. Consequently, whereas the price of a unit in an open-ended fund should nearly always track its net asset value very closely, this is not so with investment trusts, whose share price is influenced by supply and demand.

If the trust is in fashion, or performance is stonkingly good, the shares may stand at a premium to net asset value. If you buy shares in the trust in these circumstances, you will be paying more than its current assets are worth. If on the other hand demand is poor or non-existent, and performance has been indifferent or worse, the trust’s shares may well slip to a discount. The share price will then stand below the net asset value of the trust; now when you buy the shares, you will be paying less than the underlying value of its assets.

Got that? I can assure you that it isn’t as complicated as it sounds. In simple terms, buying shares in an investment trust when they are at a discount is broadly a good idea – akin to something being in the January sales. Buying at a premium, however – certainly if it is more than say 3% to 5% – is usually a poor idea in the long run. There are some nuances behind this simple formula, however!

It depends a lot on why the discount has come about. If it is because the fund manager is no good and the trust’s performance reflects that, the case for buying is weak, even if the price is a bargain-basement one. But if it is because the whole sector is unfashionable and unloved, it can often be an indication of genuine value and you should investigate it as a potentially contrarian buying opportunity. Even in the first case, it may be worth keeping an eye on the trust as the board of directors always has the power to change the fund manager for someone better. If this happens, you will tend to see the discount start to narrow, though rarely immediately, which may still give you time to get on board.

When a trust is trading at a very large premium, it may be because the fund manager is exceptionally good, or more often it is an indication that the sector the trust invests in has become highly fashionable and therefore at risk of a sudden or dramatic change in sentiment. When a trust is trading at a premium of over 10%, it strongly suggests to me that you should not be buying it. It really has to go some in order to justify that kind of fancy rating. Even top-quality fund managers can see shares in their trust go from a premium to a discount. In those cases, however, they can often go back to a premium again, so keeping a watching brief on the share price and discount can be worthwhile, since from time to time it can throw up attractive opportunities.

One of the best examples of that phenomenon over the last decade has to be the case of FIDELITY CHINA SPECIAL SITUATIONS. The story includes one of the UK’s best fund managers, a sector that has drifted dramatically in and out of favour, and the impact of huge media exposure. The trust was born when Anthony Bolton, who had successfully run unit and investment trusts for Fidelity for more than 25 years, decided after a brief retirement that he wanted to move to Hong Kong in order to run a China fund for his old firm.

Given his track record and high profile in the industry, coupled with the popularity of China as an investment theme, the launch of his new investment trust attracted a record amount of money, more than £500m. Initially the shares, issued at £1 each, performed well, and before long were trading at a premium of more than 15% to net asset value – a classic example of a warning bell sounding. What happened next was that the Chinese stock market started to perform less well, and a couple of Mr Bolton’s core stock selections turned out badly (one of his companies being accused of fraudulent accounting practices). Given his high profile, these problems inevitably hit the headlines in a big way.
The fund slipped from a premium to a discount and, worse still, the share price fell as far as 70p, well below the issue price of 100p. The media was full of stories that Mr Bolton was unable to transfer his skills from the UK to China. Some gave the impression that he was over the hill and had lost his way. Many private investors expressed their disappointment by selling their holdings at between 70p and 90p a share.

By the time Mr Bolton retired from running the fund three years later, the media was still largely hostile, some going so far as to imply that his time at the helm had been a failure. At that point the shares were still trading on a discount of 14% to net asset value. Yet the net asset value itself had risen 90%, and the trust had handsomely beaten the fund’s Chinese benchmark while he was in charge. That hardly justifies being called a failure.
More to the point, he had already laid the seeds of a high-return stock portfolio. Since his retirement the portfolio has continued to blossom under Dale Nicholls, its new manager. Eight years after launch the net asset value had risen to a peak of 300p and the shares, while still trading at a discount, were nearly four times higher than they had been at the earlier low point. Since then, not unsurprisingly, they have fallen back again; any investment in a developing economy such as China will always be more volatile than most.

The point is that those who sold out after the initial disappointing performance missed out on a chance to make a superb gain. This neatly illustrates the fact that you shouldn’t believe everything you read in the media. A little time spent in research would have suggested that the move to a big discount was actually a classic buying opportunity, not a sell signal. Given that any equity investment should be seen as a long-term project, it was a mistake for investors to sell after just two years of experience, however disappointing the ride had been.

The other point is that the Fidelity China Special Situations story illustrates how investing in investment trusts can be both more hazardous and more rewarding than investing in an equivalent unit trust, precisely because of the discount/premium cycle. It takes more work and more courage to invest this way – whether that is for you is a matter only you can decide.

Another important difference between investment trusts and unit trusts is that investment trusts can ‘gear’ their returns in a way that unit trusts cannot. What this means is that, if the board of directors agree, the trust can borrow money in order to boost the amount of capital that they have to invest. If the fund manager can make a greater return with this extra capital than it costs to borrow the money, the trust and its shareholders will be better off. (To continue the driving analogy, they have moved up a gear or two.) The scope for gearing is another factor that makes analysing investment trusts more complicated as the decision to gear or not can make a significant difference to investment performance. It also adds to the risk of share price volatility.

Each trust makes its own decision, adding to the diversity of returns. Some investment trusts never gear, believing that their portfolio is already risky enough. Gearing can work both ways. When interest rates were much higher than they are today, many trusts mistakenly geared up by borrowing at a fixed rate, in some cases locking into permanently high borrowing costs. With the march of time this problem has gradually unwound. In a world of very low interest rates, as we have today, gearing does appear to make more sense. The effect of gearing means that investment trusts in general outperform their unit trust equivalents when prices are rising in a bull market, but are certain to suffer disproportionately the next time the stock market takes a tumble. Care therefore needs to be taken when comparing unit trusts and investment trusts. In the main, the last few years have been good to investment trusts, as they have had the double benefit of narrowing discounts and gearing. It will not always be so.

Should you be put off by the greater complexity of investment trusts? I don’t think so, although it does obviously depend on how much time for research you have at your disposal. Potentially investment trusts are a rich feeding ground for the self-directed investor. There are plenty of pricing anomalies you may be able to exploit. One reason is that professional investment institutions, which once were big buyers of investment trusts, have steadily divested their holdings over the years in favour of managing their investments directly. In a market dominated by individual investors, pricing anomalies do not always disappear as quickly as they would do in the professional institutional market.

“INVESTMENT TRUSTS ARE A RICH FEEDING GROUND FOR THE SELF DIRECTED INVESTOR. THERE ARE POTENTIALLY PLENTY OF PRICING ANOMALIES YOU MAY BE ABLE TO EXPLOIT.”

In my view their complexity means that investment trusts will never be mass market investment vehicles in the same way as unit trusts were designed to be. That is actually a good thing. If they were to become more broadly owned, it would remove most of the advantages that private investors enjoy with them today. The very first investment trust, FOREIGN & COLONIAL, despite its long illustrious history, after more than 150 years is still only capitalised at £3.9bn. By contrast, in the few months after Neil Woodford launched his CF Woodford Equity Income unit trust in 2015, it had attracted more than £6bn of investors’ money. The Fundsmith Equity fund, launched in 2010, now has nearly £14bn. Now that is what I call a mass-market product – simple, easy-to-own and simple to monitor. Investment trusts will never be that, but they do have other advantages instead.

You will see in the media that financial firms such as ours are often criticised for not recommending investment trusts more frequently. There is a simple reason for this. Many investment trusts are quite small and that makes it difficult for firms with large numbers of execution-only clients to suggest them. The reason is that buying and selling shares in many investment trusts in size is difficult. The top 20 largest trusts rarely trade more than £2m in a day. This won’t matter to a DIY investor who is looking to buy or sell between £1,000 and £10,000 of trust shares, or to advisors who can spread client orders over a period of time. But for a firm like ours with more than a million clients, recommending an investment trust could suddenly swamp the market with buy orders, something that could never happen with a unit trust.

Just suppose we recommended an investment trust through our newsletter. What might happen? The market makers, the professional firms that take and implement buy and sell orders, would see the recommendation and mark up the price of the trust well before the orders came through. Buy orders on any significant scale could not all be fulfilled, leaving clients frustrated. Worse still, the clients might want compensation for failing to have their orders fulfilled, particularly if that price continues to move up. If our advice was to sell, then the problem would be even more acute.(2) This is why platforms offering execution- only services are wary of investment trusts and is why I also think they are generally unsuitable for the broadest mass market.

That does not mean they might not be right for you. If you can get to grips with understanding how investment trusts work, they can be an attractive way to invest. They can still help you even if most of your money is going into open- ended funds. I own shares in RIT CAPITAL, for example, in part because there is no open-ended alternative. The premium or discount at which investment trusts trade can also be extremely useful in seeing how investor sentiment is moving. It can be a good indicator of whether a particular sector or market is on the cheap or expensive side. If many more trusts are trading at premiums, it may be flagging up that we are near to a market top, while large discounts across a number of sectors suggest the opposite.

Having recently been appointed a non-executive director of two trusts, INVESCO INCOME GROWTH and JUPITER EMERGING AND FRONTIER INCOME, it has given me an opportunity to invest some more money in the trust sector. As a shareholder it is generally a good sign if directors of a trust have a significant personal holding in the shares. It means that their interests will be closely aligned with yours. If the investment manager is doing a poor job, the board has every incentive to try and improve the situation. Now that I am approaching retirement, I have a particular interest in generating income and I am keen to ensure that the trusts where I am on the board are making sufficiently good returns to sustain and ideally grow their dividend-generating capacity into the future.

Thirty years ago it was often said that the boards of many investment trusts were ineffectual – I recall that my boss, Peter Hargreaves, was fairly outspoken on that subject (as well as on many others). As a generalisation it had some merit. It is no accident that some of the oldest surviving trusts started life as investment vehicles for the wealth of successful merchants. They and their successors had every incentive to keep the management of their trusts on their toes, but that was far from being a universal situation, especially once the big investment management firms moved in on the action. Too often it was the external managers rather than the directors who called the shots.
Since then the quality and calibre of non-executive directors has improved by leaps and bounds. Of course, as one of the new breed of directors myself, you may be thinking: ‘He would say that, wouldn’t he?’ and you would be right.

(1) What they can do is issue more shares from time to time, either by buying them in and reissuing them, or making what is called a C-share issue. It is still a more cumbersome process.
(2) See Peter Spiller’s observation in The Investment Trust Handbook 2019

But I genuinely believe that it is nevertheless true. I would not have dreamt of agreeing to do the job unless I thought that I could make a difference. Whether or not you agree, it can only be good that more private investors are now making the effort to understand how trusts operate and to understand which boards and managers are really doing their best for shareholders.

MARK DAMPIER has been head of research at Hargreaves Lansdown, the UK’s largest independent stockbroking firm, since 1998. He has been in the financial services industry for more than 30 years, initially working as an advisor helping individual clients to invest their money. He has become one of the best-known and most widely quoted figures in the fund management industry. He wrote a regular column in the Independent on funds and markets for many years, and regularly comments in the national press and on broadcast media. Effective Investing (Harriman House, 2015) was his first book (and, he swears, definitely his last!).