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Investment trust purchases hit record high

  • Investment trusts have higher risk and potential rewards than unit trusts
  • Why they work better than open-ended funds for commercial property
  • 5 key differences between investment trusts and unit trusts
  • Most popular investment trusts.

Data published by the Association of Investment Companies (AIC) has revealed that advisers and wealth managers purchased record amounts of investment trusts on adviser platforms in the first half of 2017.

Purchases of £514 million were the highest recorded for the first six months of the year, and 74% higher than the £296 million of purchases in the first half of 2016.

Laith Khalaf, Senior Analyst, Hargreaves Lansdown:

"Investment trusts are a useful tool in the investor’s armoury, though they are more complicated than unit trusts and carry additional risks. Most importantly the effect of gearing, and the fact investment trusts can trade at a discount or a premium, amplifies both the returns and the losses that can be sustained by investors. In other words both the risks and the potential rewards are higher.

Investment trusts can be particularly useful for gaining access to illiquid assets, for instance commercial property, an asset class where the open-ended funds market experienced significant trading problems in the wake of the EU referendum result.

An investment trust structure only partly mitigates the issues experienced in this sector however, because whereas the secondary market in investment trust shares provides investors with liquidity that some open ended funds cannot deliver in periods of stress, there is still usually a price for that liquidity in the form of a widening discount.

The main benefit of the closed-ended structure for commercial property investment is from a fund management perspective. With no outflows to worry about, managers can get on with their job without looking over their shoulder, and don’t have to carry a high cash weighting to meet withdrawals in the event of an exodus from the sector."

5 differences between investment trusts and unit trusts

1. Closed-ended versus open-ended

Investment trusts are 'closed-ended' investments, usually with a fixed number of shares in issue. This effectively means investment trust managers have a fixed pool of money to invest, unlike unit trusts which create or cancel units on demand, depending on whether money is flowing into or out of the fund.

2. Premiums and discounts

A consequence of being 'closed-ended' is that the price of an investment trust is driven by supply and demand for its shares in the secondary market. If a trust is popular with investors, its price can be driven higher than its Net Asset Value (NAV) - the value of the underlying investments. This is known as trading at a premium. Conversely if supply exceeds demand the price can be driven lower than the NAV - known as trading at a discount. This is in contrast to unit trusts and OEICs, whose price is dictated by the NAV of the underlying portfolio.

So for a unit trust, investors know that whenever they buy units, they are paying a market price for the underlying holdings, so timing a purchase is less of an issue. With investment trusts, purchasers may be picking up the underlying holding cheaply (if the trust is at a discount) or expensively (if the trust is at a premium). The same applies when they are selling, so the timing of purchases and withdrawals can play a bigger part in the total return earned by the investor.

3. Pricing

Shares in investment trusts are traded on the London Stock Exchange and the price will vary throughout the trading day. Investors dealing in investment trusts will get a live price from their broker, which will be the price for their transaction. Open-ended funds by contrast are valued once a day, in most cases at 12.00 noon, and they work on a forward pricing basis, so anyone placing an order on one day will typically receive the price struck at the following day’s valuation point.

4. Gearing

Investment trust managers have the flexibility to borrow money in order to purchase investments - this is referred to as 'gearing'. Technically some open-ended funds have the ability to borrow too, though few do, except in absolute return and fixed interest sectors where leverage is sometimes obtained through the use of derivative contracts. Borrowing can enhance returns if the manager makes the right decisions, but magnify losses if the opposite holds true.

In a rising market, as we have seen over the past five years, gearing can help generate superior returns for investment trusts compared to unit trusts as the manager has more capital invested in the stock market. However, during 2008's crisis, heavily geared investment trusts suffered significantly higher losses than comparable unit trusts, which do not generally use gearing.

5. Smoothed dividends

Investment trust managers can hold back up to 15% of the income generated by the underlying investments each year. This creates a cash reserve which can be used to boost dividends in tougher times. Trusts which use this facility therefore often have more consistent dividend records - in some cases delivering many consecutive years of dividend growth for their investors. This doesn’t increase the total dividends received by investors over a given period, though it does make them less ‘lumpy’ for investors than the dividend payments from an open-ended fund holding an identical portfolio.

Most popular investment trusts with DIY investors

Below are the ten most popular investment trusts with Hargreaves Lansdown clients. Many of these names will be familiar, as investors understandably want their money run by managers with long and healthy track records, irrespective of whether they are investment trusts or unit trusts.

Hence the top ten features trusts run by Neil Woodford (Woodford Patient Capital), Nick Train (Finsbury Growth & Income) and James Anderson (Scottish Mortgage Investment Trust). Scottish Mortgage Investment Trust has performed so well of late, it was admitted to the FTSE 100 earlier this year.

Most popular investment trusts (in alphabetical order):

City Of London Investment Trust

Edinburgh Investment Trust

Fidelity China Special Situations

Finsbury Growth & Income Trust

Foreign & Colonial Investment Trust

Murray International Trust

RIT Capital Partners

Scottish Mortgage Investment Trust

Witan Investment Trust

Woodford Patient Capital Trust


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