Investment trusts are one of the oldest forms of investment vehicle, having been around since the 1860s. But while they have durability, there are many who remain reluctant to use them within a portfolio.
Historically they have been more difficult to access on investment platforms and fund supermarkets, and from the outset can seem more difficult to understand than other funds. But there are plenty of reasons to add investment trusts to a portfolio, and they can be a useful tool for anyone trying to build their wealth over the long-term.
The Benefits of Using Investments Trusts
Using investment trusts can give investors the benefit of being able to access asset classes that are better suited to the closed-end structure. Infrastructure and property are two main areas that are particularly popular with investors.
Darius McDermott, managing director of Chelsea Financial Services, says choice is a big benefit. “You simply can’t invest in things like a specialist warehouse real estate, care homes, or supermarkets in the open-ended space, for example. Investment trusts allow you to get access to very different asset classes – a number of which also pay an income, which is very important for many investors.”
Investment expert Adrian Lowcock agrees the structure can mean that trusts are a suitable way to get exposure to these more illiquid assets. “Trusts can remain liquid even if the underlying asset is not,” he adds. It should be noted that liquidity means that they could potentially be a more volatile investment than unit trusts.
Lowcock explains: “Trusts are more likely to fall further in a big market sell-off as they are listed like equities and, in the short term at least, share some of their characteristics of equities. But volatility works both ways as investors can benefit from greater gains in rising markets.”
Diversification and Income
Adding trusts which exploit niche markets can be useful in true diversification, and investors have the ability to invest in illiquid or esoteric investments.
James Burns, partner of investment management funds at Smith & Williamson says: “With investment trusts you have scope for better returns. There has been plenty of research that shows that across open- and closed-ended funds, the investment trusts often outperform.”
Additionally, revenue reserves add an interesting feature to investment trusts that are not available in open-ended funds. Trusts have the ability to keep back up to 15% of their annual income each year. McDermott says: “In 2020, this was invaluable as dividends were slashed around the world. Very few open-ended funds managed to raise or maintain their dividends (I know of three), whereas trusts could use their reserves.”
Burns believes these revenue reserves are particularly attractive for income-seeking clients. In the UK Equity Income space, for example, there have been dividend cuts, manager changes and general rebasing of dividends. But a lot of trusts have managed to increase their dividends by drawing on those revenue returns that open-ended funds just wouldn’t be able to do. He adds: “The consistency of income and income growth has been reassuring for our clients to live off income from their portfolios."
Discounts and Gearing
Investment trusts can be difficult to understand and sometimes the jargon can feel like a different language. Discounts and premiums are another part of trusts that could be of use to new investors. Simply put, a discount is when the share price of the trust is lower than the value of its underlying holdings, whereas a premium is when the opposite occurs. Discounts can mean investors can buy the trust cheaply.
Lowcock explains: “Putting money into investment trusts in challenging markets mean investors can benefit from a double discount - the lower market value and possibly the investment trust discount widening.”
Another beneficial component of an investment trust is the gearing – a way of borrowing – they can use. McDermott says: “Even modest gearing of 5 to 10% can really boost returns over time if a fund manager gets it right. Of course, this is a double-edged sword as it can also make losses larger if they get it wrong.”
But he adds: “I wouldn’t suggest the average investor looks to actively buy and sell around them all the time, but there are moments when a trust is on a discount and becomes a bargain buy."
He uses the example of last year's sell-off when everything fell, and supermarket REITs also fell to a discount: "They were the only things still open and meeting higher demand. These REITs had been oversold on sentiment and were a screaming buy.”
The Benefits of a Board
Investment trusts benefit from having an independent board with oversight of the manager. The board keeps on top of how the manager is running money and can always move the mandate to another manager if it believes the manager is not up to the job.
Burns says: “Boards have been shown to be much more independent in recent years; there is far more scrutiny of how the managers are performing and if they're not doing a good job, there's pressure to bring in a new team within that firm or the mandate can be moved away from that firm entirely. That means that the shareholders are getting a good manager in charge. There's minimal deadwood in the sector.”
Using investment trusts for the first time can be daunting, especially with the jargon and understanding all the moving parts compared with unit trusts. They are, however, not as tricky to understand as they first appear, and can certainly add diversity to a portfolio.
