Why Investment Trusts? – M&G Wealth Article

Investment trusts have delivered excellent long-term returns for shareholders for over 150 years, but are still sometimes referred to as ‘The City’s best-kept secret’. In the first article of a new series from Baron & Grant Investment Management Limited, John Baron, Chair of the Investment Committee explains what they are and the key structural advantages which have accounted for their superior returns.

Future articles will explore the merits of investing in investment trusts for those seeking income and a ’positive impact’ remit, as well as the convenience of using a DFM which specialises in investment trusts. We will also highlight the importance of M&G Wealth Platform’s dealing desk capability and strength in being able to manage investment trust focused portfolios.

Despite not being well known, investment trusts on average have outperformed their better-known cousins – unit trusts and OEICs. Furthermore, investment trusts have beaten most of the market indices whether delineated by region or country – unlike unit trusts, OEICs and ETFs 1. However, they have often been neglected by advisers in part because of their slightly more complex structure. Yet this has been overplayed.

Unlike unit trusts or OEICs, investment trusts are ‘closed-ended’ – they have a fixed number of shares like other close-ended public companies such as M&S and BP, but instead of specialising in clothes or oil, they specialise in financial assets. Accordingly, the managers of investment trusts can take a long-term view of their assets as they are not subject to the same relentless flow of monies, both being introduced and withdrawn, as are open-ended funds. Investing for the long-term tends to result in better returns.

This structure also helps the managers achieve their superior performance in other ways. Like other public companies, trusts can borrow to buy more assets. Historically, this has benefitted asset values and share prices in part because markets have risen and because good fund managers have capitalised on this gearing. Lower fees have also assisted performance in the past.

Being closed-ended, investment trusts are also better suited for certain types of investment – particularly those less-liquid, such as commercial property. This differential was highlighted by the closure of a number of open-ended property funds during the mistaken rush to the door following the EU referendum. Other less-liquid assets such as private equity and smaller companies require a similar approach. Their very nature and therefore at times illiquidity require the incubator effect best offered by the structure of investment trusts.

Another key structural advantage, particularly for those seeking income, is the ability to build up ‘Revenue Reserves’. Unlike unit trusts, in any one year investment trusts can retain a percentage of their dividends and income received from holdings in the underlying portfolio.

This reserve can be used to supplement dividends going forward to help ensure a smooth progression even when, within reason, the underlying economy and/or markets go through a rough patch and portfolio holdings see dividend cuts. Data from the Association of Investment Companies (AIC), the respected trade body for investment trusts, has shown that 85% of income paying investment trusts maintained or raised their dividends during the pandemic – this is a proud record given the market backdrop 2.

This ability is important to those investors seeking income – and understanding the extent of reserves is a key factor when selecting relevant investment trusts. Furthermore, legislative changes now allow investment trusts to dip into their capital to supplement or pay a dividend. More trusts are doing this which, within reason, is welcome as it better allows income investors to gain exposure to low-yielding but high-growth sectors.

Another advantage of investment trusts is that they tend to exhibit greater transparency for their shareholders. Like other public companies, investment trusts have an independent board of directors whose brief and legal responsibility is to represent shareholders – and these directors have teeth! Shareholders themselves have significant powers. They can vote on issues such as changes to investment policy and the appointment of directors. They can attend shareholder meetings and ask questions – it is, after all, their company.

Courtesy of this transparency, it is difficult for investment trusts to hide in the shadows because of mediocre performance, certainly when compared to lacklustre unit trusts. They are on notice – reward shareholders or questions will be asked. This is one reason the industry continues to evolve in response to shareholders’ investment requirements.

The AIC is also on the side of shareholders and has done sterling work in recent years to raise awareness and better inform and educate. It also works towards creating a better investment landscape for the sector, and recent campaigns have included trying to achieve regulatory improvements to the cumbersome and misleading Key Information Documents (KIDs).

The price investors’ pay for accessing this superior performance is that investment trusts can be more volatile when markets are unsettled. Like other public companies, their price is largely governed by supply and demand for the shares. Prices are not directly linked to the portfolio’s Net Asset Value (NAV) as is the case with unit trusts or OEICs – and sentiment can sometimes be fickle. This is why they are best suited to the long-term investor and one reason why we include ETFs in our portfolios as they can help to dampen overall volatility.

So welcome to the world of investment trusts – if properly harnessed, they can make a powerful contribution toward helping investors attain their financial goals.



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