Researching trusts

STUART WATSON has been investing in investment trusts for 25 years and contributes regular in-depth fund profiles to the Money Makers subscription service. Here he explains what he looks for when researching new holdings.

Investment trusts have been the mainstay of my portfolio for much of my time in finance. A few years ago, as semi-retirement loomed, I decided I wanted to learn a lot more, both about the trusts I already held and about the sector as a whole.

They say one of the best ways to learn about something is to write about it. So that was what I did, setting up a blog called itinvestor.co.uk to publish a new piece every week.

My early blog posts were a little simplistic, but they got much longer and more detailed as the months passed, and I built up a broader understanding of the sector.

I started using a template to give my articles a more consistent framework. Then the opportunity arose to join Jonathan Davis at Money Makers, and I now write weekly fund profiles for the Money Makers website (money-makers.co). Here I am going to break down the template I use, to provide a little colour around what I look at in these profiles and why.

What I look for in a trust

My preferred investing style is a mixture of a little caution, a lot of stubbornness, and a side helping of lethargy.

I am comfortable with some risk, but I don’t feel the need to significantly beat the market every year. I am happy to give managers time to work through what appear to be temporary issues, such as their style dipping out of favour for a while. I prefer trusts that I can hold for several years without worrying that they will significantly change their underlying strategy. As one of my former work colleagues was fond of saying, “Don’t change horses mid-stream.”

The fund profiles are written with this philosophy in mind, so I tend to avoid short-term discount plays and generally steer clear of both regional and country-specific trusts, preferring to concentrate on a few big themes and global equity trusts.

A little bit of history

An investment trust has the ability to completely reinvent the way it does business, getting rid of its managers and totally changing its investment focus. In some instances, this means a trust’s history may have little if anything to do with its prospects today. Other trusts have had the same manager and broadly the same investment style for many decades.

Therefore, the first step I take is to see what a trust has done in the past and consider how far back you can meaningfully go when looking at its track record.

I look for manager changes, at both individual and firm levels, and also for major strategy or benchmark changes. That said, older reports rarely mention individual managers by name – often the first time you come across them is when they retire and are thanked for their service!

Most investing websites only have data that goes back ten years, but a trust’s own website often has accounts dating back to the early 2000s. Looking at old ten-year summaries can pretty quickly give you a three-decade overview of how a trust has performed. How the presentation of key data has changed over time can be revealing as well. I prefer trusts that have consistently used the same metrics over a long period.

Companies House is another great resource and often has accounts going back to the mid-1970s, although the quality of the photocopying becomes ever more suspect the further back you go.

Sometimes a trust’s history will surprise you. For example, looking at Scottish Mortgage reveals how little of its portfolio was in technology stocks before the financial crisis, even though James Anderson first took charge in 2000, several years before sub-prime mortgages wrecked the banking system. Indeed, many trusts that you would instinctively think of as being widely globally diversified today were heavily UK-focused until quite recently.

In truth, it would be nice if I didn’t have to dig through old reports to get a lot of this information. It seems like the sort of thing that should be set out clearly on a trust’s website or in its accounts.

Key statistics

Once a trust has been properly introduced, I like to summarise a few key numbers.

A lot of this information is widely available, but it’s handy to skim down items like price, size, discount, sector, performance, benchmark, managers, number of holdings, charging structure and so on in one swoop. Quite often I find this process highlights some of the areas I want to examine in greater depth.

Investment policies

Each trust will have a set of guidelines on what it can invest in, usually specifying maximum amounts for certain types of holding and position sizes. I check these against what the trust is actually invested in, to see whether it is bumping up against these limits or whether they seem to have little relevance in practice. Looking back at how this has changed over time can also be revealing.

ESG policies are becoming increasingly common, although they tend not to be something I focus on explicitly. The trusts I prefer often fall into the quality camp, so by default, their investments tend to be more sustainable businesses.

Inside the portfolio

I like to get a feel for what I am invested in at the company level, although I rarely delve into lots of detail on individual positions as that tends to be very time-consuming. Rather, I am looking for obvious red flags, a feel for the overall level of diversification across sectors and geographies, and the types of companies held. No investor gets everything right, so I don’t feel the need to agree with every single position a manager has taken. With specialist trusts, it can be hard to get much information about the underlying holdings anyway.

I prefer more concentrated portfolios of, say, fewer than 30 positions as I believe that provides more opportunity to outperform. But individual positions greater than 10% can make me a little twitchy, especially when they represent a significant proportion of that particular company’s issued share capital, potentially making them more difficult to sell.

Looking at a trust’s portfolio can also tell me how much it overlaps with trusts I already own. There are significant shared holdings across many Baillie Gifford trusts, for example. I try to keep my portfolio below 20 trusts, to keep things more manageable, so I often avoid trusts that duplicate a lot of what I already have.

Portfolio turnover is something else I like to examine, and lower is generally better in my opinion. Sometimes a manager will provide commentary on this, and sometimes you need to look at the cash flow statement and compare the amounts bought and sold relative to the size of the trust’s assets.

Paid-for broker notes from the likes of Edison, Kepler and QuotedData can be useful sources of information, as they often go into detail about how managers construct their portfolios and size their positions, which is something often not discussed in their reports and presentations.

Another useful source of information, especially for newer trusts, is a prospectus for an IPO or a recent placing. These can run to a few hundred pages, but there is usually a chapter or two covering the market opportunity and investing strategy and these often provide a lot more background detail than you see in a set of accounts.

Finally, the tone of how a manager talks about their holdings and performance can also be revealing. I prefer the modest and understated approach, owning up to bad decisions but not getting too carried away when times are good.

Performance

Assessing a trust’s performance is a dark art, at best. Changes to a management team or strategy may mean there is only a limited period you can look back through and still make a sensible comparison. And the further back you go, the harder it is to get good-quality information.

I like to look for consistency of outperformance, preferring my trusts to be frequently good rather than occasionally great. That suits my hands-off investing style and should make a trust easier to hold onto when the markets hit a rough patch.

One thing I am a fan of is how some J.P. Morgan trusts break their performance for each period down into factors like stock selection, currency, gearing and charges. It would be good to see this approach more widely adopted.

Each trust has a different objective, though, and it is important to compare its performance against a sensible yardstick. Sometimes a trust’s stated benchmark seems completely inappropriate. HgCapital Trust, a tech-focused private equity trust that I have held for many years, still compares itself against the FTSE All-Share, one of the major indices with the least amount of technology exposure. For many years up until March 2020, Murray International used a mixed benchmark with a 40% weighting to UK stocks although its typical UK weighting was a fraction of that.

It is worth comparing a trust against others in its sector, although even within a sector there can be a number of different styles. The flexible sector is probably the most diverse in this respect. Typically, the more trusts there are in a sector, the more it will make sense to cherry-pick from the most similar trusts. With many of the newer alternative asset trusts, the income and total return expectations outlined in their IPO prospectus make another useful comparator.

I also like to see how trusts perform when markets go through big declines, like the financial crisis, the last quarter of 2018 and the first quarter of 2020. This can give a sense of how defensive they might be when the next bear comes along.

Directors and managers

I am probably more interested in a trust’s managers than in its directors, but I do like to see a board that has a good mixture of industry and investment trust experience. The length of service and how many other directorships they hold can also be revealing. You want to be comfortable that they are not too cosy with the managers and can devote sufficient time to the trust.

I do look at how many shares the directors hold, but it’s hard to know how meaningful any position is with respect to any individual’s net worth. Often directors will buy shares over time, so those who recently joined may have much smaller positions.

While I like to see alignment with shareholders, I have grown warier of very large stakes held by key individuals as that may give them a bit too much control and lead to persistent large discounts.

I consider the stakes held by a trust’s managers to be more important, although reporting this is voluntary and, disappointingly, many trusts do not mention it at all.

Another piece of information you often have to dig around for is how old the managers are, so you can estimate how close they may be to retirement. What other funds they manage and how large a trust is relative to the management firm’s overall assets under management can also give a sense of where the trust might sit in their list of priorities.

Succession is an issue I have been looking at more and more, and I like to see a clear indication that there is a team behind the main man or woman and that a suitable deputy can step in if needed. Firms like Baillie Gifford seem particularly good at smooth transitions from one manager to the next, but at smaller investment houses it is often unclear how deep their bench is. This is another area where I feel some standardised disclosure would be helpful.

Discount control and rating

Some trusts are very keen to minimise their discount or premium and have a clear discount policy control, while others show little if any interest in the subject. It is useful to know where a trust sits on this spectrum.

For smaller trusts on a discount, there is often little they can do – as reducing the size of the trust via buybacks or tender offers may make it less attractive to investors and worsen the problem. Other trusts, like Lindsell Train Investment Trust, have structural issues that make it unfeasible to buy back or issue shares.

Regardless of what a trust says it aims to do, it can be instructive to look at how its discount has moved over time and how regularly it is either bought back or has issued new shares. Comparing a trust’s current discount to others in the sector can give an idea of how well it is perceived by other investors, although it can be difficult to get historical comparisons for this.

It is rare to find a trust that has not been on sale at some point, so getting a feel for how its rating has moved over time can be helpful if you want to build up a position gradually and snap up a bargain while doing so.

Furthermore, the rise of alternative asset trusts has meant we are seeing an increasing proportion of trusts that are valued on only a quarterly or semi-annual basis. Some hybrid trusts include a mixture of quoted and unquoted investments, with the former valued daily and the latter much more infrequently. Understanding the valuation cycle helps get a better feel for how valid the latest stated net asset value actually is.

Charges

Charges vary a lot between trusts. There are flat percentage fees, tiered fees, fees on total assets, fees on net assets, fees on market value – and then the hornets’ nest of performance fees. Before writing about trusts on a regular basis, I would have said I was fairly indifferent to performance fees, but I have definitely cooled towards them in recent years.

In some cases, performance fees can massively outweigh the basic fee, and it is rarely clear exactly how they have been calculated, where the high-water marks are, and exactly how much has been paid out over the long term. You never see a simple table explaining what is due, merely being presented with the total amount.

Some performance fees are as low as 10%, while others are 15% or even 20%. The hurdle to be jumped is often the trust’s benchmark index, but sometimes it is a relatively low fixed amount that is very easy to beat.

In terms of the basic management fee, I like to see if the rate charged has moved lower over time or if tiers have been introduced so that the average rate falls as the trust grows in size. Tiered fees are particularly important in the case of alternative asset trusts, given how they seem to grow so quickly in size. The concern with flat fees is that managers have a much greater incentive to hoard more and more assets rather than focusing on the quality of what they are buying.

Dividends

I am more in the total return camp when it comes to investment returns. However, it is still handy to look at the dividend track record and to get an understanding of whether a trust only pays out from the income it receives or whether it is regularly dipping into capital. We have also seen an increasing number of trusts adopt so-called enhanced dividend policies where a fixed percentage of net assets is paid out each year.

When it comes to trusts with an income focus, it is good to see that any dividend targets laid out are consistently met and are increased over time as you would expect.

Gearing

Gearing is another area where investors could do with a little more clarity. It is easy to find the current level of gearing, but not so simple to get data on historical movements.

I also find it useful to consider gearing and performance together. A more highly geared trust should, over longer periods, do better than a more lightly geared one.

Of course, in times of market stress, highly geared trusts are likely to see their net asset values fall more sharply.

Closing thoughts

The way I look at trusts has changed quite a lot in the last few years, and I suspect it will continue to evolve. That is a key reason why I like producing these profiles.

There is always something new to learn about the sector and, if anything, the rate of change seems to be accelerating, with the wide variety of new trusts we have seen in recent years including areas as diverse as music royalties and space exploration.

 

This article first appeared in The Investment Trusts Handbook 2022.

Investment trust basics

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

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. Funds are able to buy and sell investments without paying tax on realised gains.

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 £250bn of savers’ assets are invested in investment trusts. The first investment trust was launched as long ago as 1868, so the sector has a long history. Sales of open-ended funds (unit trusts, OEICs and UCITs funds) have grown faster, but investment trust performance has generally been superior.

How do they 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) on a range of things, including the election of directors, changes in investment policy and share issuance. Trusts can also, unlike most open-ended funds, borrow money in order to enhance returns. Whereas the number of units in a unit trust rises and falls from day to day in response to supply and demand, an investment trust is able to deploy permanent capital.

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) per share of the company. At other times, they will change hands for more than the NAV per share.

The difference between the share price and the NAV per share is calculated as a percentage of the NAV and is called a discount if the share price is below the equivalent 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 borrowing, this has the effect of producing higher returns. The reverse is also true, meaning that gains and losses are magnified. Investment trusts typically borrow around 5–10% 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 whenever they need, rather than 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 directly accountable to the shareholders is important. So too is the ability of boards to smooth the payment of dividend income by putting aside surplus revenue as reserves.

Because their capital base is permanent, investment companies are free to invest in a much wider range of investments than other types of funds. In fact, they can invest in almost anything. Although many of the largest trusts invest in listed stocks and bonds, the biggest growth in recent years has been in a range of more specialist
areas, such as renewable energy, infrastructure, debt securities, and private equity. Investment trusts offer fund investors a broader choice and greater scope for diversification, 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 their shares at that point. The day-to-day value of the investment will 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 were just over 300 investment trusts with more than £260bn in assets (as at the end of November 2025). They are split between a number of different sectors, reflecting the regions or types of investments in which they invest. Scottish Mortgage, the largest trust, has approximately £15bn in assets.

What are alternative assets?

While investment trusts have traditionally invested primarily in publicly listed stocks and shares, whose values are known every day, the last decade has seen significant growth in so-called alternative assets. These are trusts which invest in longer-term assets, which are mostly not traded daily and therefore can be valued only at less frequent intervals. Examples include commercial property, renewable energy, infrastructure and private equity. Many of these alternative trusts are popular because of their ability to pay higher levels of income.

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, and is legally bound by the requirements of successive Companies Acts.

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. A few 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 (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 have a number of tax advantages, reflecting their higher risk. VCTs invest in start-ups and early-stage businesses.

Who owns investment trusts?

Twenty-five years ago, life insurance companies were the biggest investors in investment trusts, which they used to manage their client funds and pensions. These days, such institutional investors mostly manage their own investments directly. Other than some specialist types of trust, the largest investors in trusts today are wealth management firms (formerly stockbroking firms), other types of intermediaries and, increasingly, private investors. The growing number of individual investors reflects the growing influence of online platforms, which give individual investors the ability to choose their own investments for ISAs, SIPPs and taxable share/fund accounts.

Are they difficult to understand?

Investment trusts are a little more complex than a simple open-ended fund, but no more difficult to understand than most types of listed companies. It is important to understand the concept of discounts and premiums before you start to invest, but buying, selling and following the fortunes of your investment could not be easier. If you like the idea of making the connoisseur’s choice when investing, you will find the effort of understanding investment trusts worthwhile.

Using trusts to diversify

Industry expert ALEX DENNY explains how using investment trust with different styles and objectives can reduce the risk of investing in financial markets. This article was first published in the 2018 edition of the Investment Trusts Handbook and has not been updated.

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.

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.

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 as an example. It is an actively managed investment trust whose manager, Nitin Bajaj, focuses on buying good, well-run businesses which he judges to be 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.

 

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.

Taking the plunge

Investment trust expert MAX KING offers advice to private investors on how to benefit from closed-end funds. This article was first published in the 2018 edition of the Investment Trusts Handbook and has not been updated.

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.

Trusts & private investors

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. This article was first published in the 2018 edition of the Investment Trusts Handbook and has not been updated.

Becoming more popular by the day

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. 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.

China is a good example

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.

A rich feeding ground for the self-directed investor

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. 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.

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 was head of research at Hargreaves Lansdown, the UK’s largest independent stockbroking firm, from 1998 to 2020. 


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