Investment Trusts

ITs could potentially provide a complete range of tailored products for the retail investor. But.....

Investment Trusts(ITs) are closed-ended funds. Check you know what that means. Funds

Investment freedom

An open-ended fund manager is driven to sell when investors are selling and buy when investors are buying. Given the well-documented habit of small savers to sell at the bottom of the market and buy at the top, this is the reverse of what he should be doing. And the passive holder of units in the fund is dragged into this decision - sharing, as a unitholder, in the subsequent adverse consequences of the actions triggered by other misguided investors.

ITs, by contrast, can take decisions on exposure to the market quite independently of other investors. This usually includes the ability to use leverage - buy shares with borrowed money - a double-edged delight denied to open-ended funds (OEICs).

Other matters

A distinctive feature of ITs is the discount. This is of great interest to analysts and very important when choosing a fund. But we regard it as largely irrelevant to the closed vs. open debate for long-term savers.

IT costs are generally slightly lower than similar OEICs.

In summary, OEICs are simpler for the small saver to cope with. But more sophisticated investors comfortable with direct investment in shares are more like to prefer ITs.

But......oh dear!

Unfortunately, ITs have never quite shaken off the whiff of the cowboy. And every so often, just when the odour has almost cleared, another one rides into town.

Typical of the genre was the split-capital trust scandal at the turn of the century. The legal rights and wrongs of the affair were never settled although a compensation fund was set up. The regulator finally gave up in 2007. Whatever the outcome, two things are true:

• The trust managers involved gave the appearance of being either crooked or stupid. Neither attribute is desirable.
• No commentators saw this coming. Split capital trusts were still being recommended in reputable advice to the general public as late as 2001 when the first troubles were already surfacing.

Our view

Do not invest in trusts with more than one class of capital. Tiered capital structures reflect the wishes of salesmen, not financiers. How do you think the rights of the different classes of shareholder are distinguished?

This embargo should be extended to trusts which have warrants outstanding. Warrants are not shares, but are options to buy shares. Option holders want volatility. You do not.

Large, long-established, broadly-based, conservatively-managed trusts can safely be recommended as low-cost tracker-type investments. Minority trusts with clear objectives (investing in Asian economies, for example) and well-regarded management are the best way of investing in specialised areas if you like to do that sort of thing. For the rest, until the whiff of saddle-sweat dissipates.......