As part of a recent series of seminars we hosted in London on the benefits of Investment Trusts, we were treated to a talk from Investec Wealth & Investment’s Head of Fund Research and Collectives, Andrew Summers. Andrew asked the important questions: What are some of the biggest impediments stopping investors from choosing investment trusts? How do closed-ended vehicles perform against open-ended? And why do so many investment trusts have such strange names?
Andrew kicked things off by exploring an investment trust’s many moving parts. He identified how daunting some of these can be to many investors. He highlighted that investors need to get comfortable with their fund manager, with the board, and with discount control members. As an investment trust has both a NAV and a share price, and because NAV deviates from the share price, he suggested that an investor will need to find out if the board has policies in place to limit this. An investor will also have things like tender offers, share buy backs, continuation costs, revenue reserves, and dividend policies to think about. Andrew stated that this complexity puts many people off.
Another factor that Andrew suggested is responsible for investors not getting involved in the the investment fund universe is that it’s much smaller than the open-ended one:
“There are about 800 investment trusts and there are over 40,000 open-ended funds in the UK. The investment trust universe is worth about two hundred billion GBP, compared to the one trillion pounds worth of assets in other types of vehicles. About 25% of investment trusts haven’t bitten off a spread of more than 3%. A quarter of investment trusts are less than two hundred million GBP in size. An eighth trade less than 100,000 shares a day. Half of the investment universe is difficult to buy, and the other half is difficult to get your head around.”
Andrew argued that this creates great opportunities for investors who, unlike the majority, have the time, inclination, and aptitude to do the work.
When discussing how closed-ended vehicles performed against open-ended, Andrew cited one of the first academic studies into the performance of investment trusts. The study found that closed-ended funds tended to outperform open-ended by almost 140 basis points per annum. 50 basis points were attributed to the fact that investment trusts, thanks to the fixed nature of their capital, can invest in smaller companies. Although the remaining basis points are yet to be attributed to any one thing, Andrew theorised that this is down to fund managers who are given a fixed pool of capital can take a longer-term approach to investment.
Andrew used smaller companies manager Aberforth as an example. Aberforth’s open-ended fund has to deal with redemptions every day, and therefore does not own more than 10% of the free float of any company. Their closed-ended fund, not having to worry about redemptions or subscriptions, gives them the ability to own up to 20% of the freefloat of the companies they care about most. As a result of its more fixed nature, it is also able to invest in stocks that are illiquid. Another benefit that Andrew described was his feeling that a manager of a closed-ended fund is more likely to have a shareholder’s interests at heart.
They will not take on more money if they don’t believe they can invest it wisely. That is not to say that all investment trusts are created equal.
Andrew went on to explain that, for him, the investment trust universe can be separated into three categories:
The 10% that deal with assets that absolutely have to be accessed by the closed-ended format e.g. infrastructure or private equity.
The 50% that have a preference for the closed-ended format but will adopt an open-ended one if necessary.
The 40% that do not utilise the investment trust structure in a way that compensates sufficiently for the additional risks and complexities that investment trusts bring.
For Andrew, he identifies the 50% as being a good fishing ground for opportunities, providing him with the option to decide whether he wants to go down an open-ended or closed-ended route.
Andrew also discussed one of the primary risks (or opportunities, depending on your perspective) associated with investment trusts. In 80% of investment trusts, share price volatility is higher than their NAV volatility by an average of 4%. The drawdown of a typical investment trust share price tends to be greater than the drawdown of their NAV. Andrew hastened to add that this shouldn’t come as a surprise. He reinforced the fact that investment trusts have a different set of risks to open-ended funds and that, for the right type of investor, those additional risks can be compensated for by additional return.
