23rd May 2013
It is tempting to see the investment trust industry as archaic. The names of the trusts hark back to a belt-and-braces City era, while board members and chairman all shot grouse together. But viewing the sector as a relic is to miss some of the important innovation that has happened in the sector of late. Investment trusts are pulling themselves into the modern era writes Cherry Reynard.
Many of the innovations have centered on income. The cannier investment trust boards have realised that they are at a natural advantage: investment trusts can reserve income, for example; they can also pay income out of capital, giving them more flexibility on how and when they pay money to shareholders. This gives them a headstart over open-ended funds in income-starved times.
The ability to pay income out of capital has enabled some managers of more ‘alternative’ investment trusts to pay an income. This has had a knock-on effect of significantly reducing the discount to net asset value. For example, the Aberdeen Private Equity trust has recently started to pay a distribution to its shareholders – 10% of all distributions it receives, which amounted to 3% last year. This cut the discount by around half.
James Saunders-Watson, head of sales and marketing for investment trusts at JP Morgan Asset Management, says: “The HMRC changes on capital distribution have been really useful for those trusts that have capital growth, but don’t have an income return, such as private equity. It offers a means for them to offer a regular payout for investors.”
Equally, there have been a number of launches of income versions of popular ‘growth’ asset classes. For example, there is the BlackRock Commodities Income investment trust, or the JP Morgan Emerging Markets Income trust. There have been new launches in the debt sector, after changes to the rules meant it was no longer tax inefficient to hold bonds.
It has been a perennial gripe on investment trusts that the discount mechanism introduces a measure of volatility not present in the open-ended sector. Certainly when investors are hit with falling asset prices and a rising discount – as has been seen in the private equity or property sectors, for example – it can be very painful.
There is also little doubt that older trusts have been slow to address the problem, but they are being increasingly shown-up by newer trusts, launched with innovative discount mechanisms. For example, the BlackRock Frontiers fund was launched with a mechanism that allows investors to redeem at net asset value after five years. This has helped keep the discount low, particularly in this relatively illiquid part of the market.
Annabel Brodie-Smith, head of communications at the Association of Investment Companies, says: “A couple of companies have introduced zero discount policies – for example, the Personal Assets trust, run by Sebastian Lyon at Troy Asset Management. This trust has grown a lot and other companies are looking to replicate its structure.” Saunders-Watson says that it is now difficult to launch a fund without a continuation vote built into the structure.
The effect has been profound. Discounts have been steadily reducing since 1998, more companies are using buybacks to manage discounts – Alliance Trust, for example – and now 100 trusts in the sector (around a quarter) trade on a premium to net asset value.
Liquidity has historically been a problem in certain trusts. While investment trusts have the advantage of not having to deal with flows in and out of the portfolio in the same way as open-ended funds, there have been complaints that it is difficult to deal in some trusts in large deal sizes. While this has generally not been a problem for individual investors, here too investment trust boards have woken up to the problem and are trying to address it: Saunders-Watson says that there is an increasing amount of ‘tap issuance’ – periodic issuance of shares – which provides more liquidity for the trust. Trusts such as City of London and Murray International are using this type of strategy to improve liquidity. The sector saw £1.4bn in new assets into IPOs over the first three months of the year, according to Winterfloods – reported here on Citywire. This should also improve liquidity.
This is part of a wider example of trust boards shaping up, even those of the older trusts. Analysts are increasingly putting pressure on boards to be more active and earn their directors’ fees. Mandates such as SVM Global and UK Select have changed hands in recent months. After the report last year by Canaccord Genuity’s Alan Brierley ‘Skin in the Game’, boards have come under pressure to have higher personal holdings in their own trusts.
Investment trusts have also been the favoured structure for a number of new, more esoteric launches. Brodie-Smith points out that there has been everything from property debt to wind technology among the recent launches in the sector shown on the AIC website. Increasingly investment trusts offer asset classes that are simply not available in any other structure.
There remain some problems. Comparable information is a challenge. While open-ended funds have standardised information, investment trust information is still complex and may vary considerably from trust to trust. There are problems of platform access, with many of the larger fund supermarket platforms still not offering investment trusts. And of course, there remain a number of trusts with weaker performance and boards that don’t seem to care in comparison to their more fleet-footed peers, but – ultimately – similar accusations could be levelled at any structure. The investment trust sector is modernising and investors should re-examine it.