Investment trust stars

Some investment trust sectors experienced particularly wide movements, such as UK direct commercial property trusts. A number of these traded on premiums to NAV as at 23 June, with the sector at an average discount to NAV of 2.5 per cent, according to broker Winterflood.

But as investor concerns over UK commercial property grew following the referendum, and open-ended funds suspended redemptions in early July due to a deluge of outflow requests they couldn't meet, premiums on UK direct property trusts fell to discounts, or discounts widened. By the week ending 8 July, nearly every UK direct property trust was on a discount to NAV and the sector average was a discount of 12.7 per cent.

However, these have bounced back as investors become calmer about UK commercial property and Brexit, while many open-ended funds have reopened. By the week ending 21 October, many UK commercial property trusts were back on premiums to NAV, with the sector on an average discount to NAV of 1.8 per cent.

European-focused equity trusts have also experienced substantial discount widening since the referendum in June. James Carthew, head of research at QuotedData, highlights Henderson Eurotrust (HNE), which is trading on a discount of about 10 per cent, in contrast to its 12-month average of about 4 per cent, and JPMorgan European (JETI), of which the income shares trade at a discount of around 14.5 per cent against its 12-month average of 6.8 per cent.

He says that contrarian investors (with a high risk appetite) might find UK smaller companies investment trusts interesting, as many are on double-digit discounts which are mostly wider than their 12-month averages. However, a lot of uncertainty hangs over this area, because what the effects of leaving the EU on UK domestic-facing companies is unclear. But Mr Carthew adds that this area could do well over the next couple of years - especially exporters, which should benefit from a weak sterling.

Private equity upheaval

Private equity investment trusts, meanwhile, have experienced discount tightening due to the takeover battle for SVG Capital (SVI).

Private equity firm HarbourVest initially made a takeover offer of 650p a share on 12 September, which SVG Capital's board rejected. It then held talks with several other potential bidders, proposed and abandoned an agreement to sell half its portfolio to Pomona Capital and Pantheon Ventures, and entered into a deal to sell its portfolio to Goldman Sachs Asset Management and Canada Pension Plan, which it also subsequently dropped.

It has finally agreed to sell its portfolio to HarbourVest for about £806.6m, a 0.6 per cent premium to the £802m value of the portfolio as at 31 July. This is equivalent to 715p a share net of estimated costs.

SVG Capital expects to return about £1.1bn capital to its shareholders via three tender offers of up to £350m at 715p a share before the year-end, in February 2017 and March/April 2017, and a final capital distribution in the second or third quarter next year.

A general meeting to get shareholder approval to do this will take place before the end of the year.

HarbourVest's method of acquiring the trust - buying its portfolio rather than a formal takeover - is unusual in the wider investment trust sector. While this is theoretically easier for the acquirer than a formal takeover, Simon Elliott, head of the investment trust research team at Winterflood, doesn't think there will be more of this among mainstream sectors, such as equity trusts - it is easy enough to buy mainstream equities on the market.

But there could be other such acquisitions among trusts investing in more unusual, unlisted assets. Alternative Asset Opportunities (TLI) has recently agreed to sell its portfolio of US life insurance policies.

Electra Private Equity (ELTA), meanwhile, has also succumbed to corporate activity after activist investor Edward Bramson finally got a place on its board last year after he started building a stake in the trust with his Sherborne Investors (SIGB) vehicle in 2014. Despite strong historic performance and a relatively tight discount to NAV relative to its peers, Mr Bramson argued that Electra's performance had been in decline, but with changes he could improve it.

The trust has undergone a number of board changes since then and launched a strategic review of its investment policy and structure, of which it has recently published the results of 'phase 1'.

Electra's board plans to terminate the contract with the trust's current manager, Electra Partners, in May next year and internalise the management. It also plans to move from an investment trust structure to "a corporate structure over time as it believes this could result in reduced expenses and reduced discounts to underlying portfolio value".

And it plans to return £200m to shareholders later this year via a tender offer. Electra's board says the benefits include saving recurring expenses of more than £25m, reducing share price discounts to NAV and eliminating carried interest, which totalled £80m in the past 12 months.

"We are sorry to see that the board has now confirmed the sacking of Electra Partners as managers from June 2017, given that the team has made many good investments and strong returns for shareholders over the years," says Iain Scouller, managing director of investment funds research at Stifel. "The move to a corporate structure...presumably will result in a different approach to the investment strategy, compared with the current one which has been tried and tested, and so successful over the years."

He also points out that losing investment trust status may mean that when Electra realises investments there may be a different tax treatment. Investment trusts can realise investments without liability to capital gains tax.

The corporate activity means the sector could be set to shrink, because as well as the actions at these two trusts, a number of private equity investment trusts are in managed wind-down: Candover (CDI), Dunedin Enterprise (DNE), LMS Capital (LMS), Mithras (MTH), Northern Investors (NRI) and Private Equity Investor (PEQ). And large unlisted private equity companies have a good deal of cash to invest, according to Alan Brierley, director, investment companies team at Canaccord Genuity, so they could look to deploy it in this area via similar actions.

An attraction for them could be that the sector offers some value, according to analysts such as Mr Elliott - even after the discount tightening. Most of the trusts still trade at discounts, and generally have strong balance sheets and good growth prospects.

Mr Carthew adds. "The SVG Capital transaction underscores the value opportunity in the private equity sector. SVG was able to sell its entire portfolio at a premium to the last published NAV."

Low issuance

This year has been a weak year in terms of issuance, with £3.02bn raised over the first nine months of the year compared with £6.5bn over the first nine months of 2015. "This represents a fall of 53 per cent and, with only three months remaining of the year, it appears likely that 2016 will be the weakest year for fundraising since 2012," comment analysts at Winterflood. "This reflects both weaker demand for equity-orientated mandates from retail investors and an almost non-existent initial public offering (IPO) market."

Of the issuance that has taken place a lot of this has been in income-orientated sectors, with infrastructure accounting for 44 per cent, and property 20.5 per cent, according to Winterflood.

There has only been one investment trust IPO this year, when Hadrian's Wall Secured Investments (HWSL) raised £80m in June. This is in contrast to the nearly £11bn raised between 2013 and 2015, with income-focused launches accounting for a number of issues, along with Woodford Patient Capital Trust's (WPCT) mammoth £800m IPO last year. The dearth of issues in 2016 was in part because investors were waiting to see the outcome of the referendum on the EU.

However, Winterflood adds: "We would not be surprised to see one or two others come to the market before the end of the year, although the preference among investors seems to be for well-established funds that already have a proven track record and a history of paying dividends."

An IPO for the first half of 2017 has already been flagged, with the launch of The People's Trust. This hopes to raise £100,000 in the coming months via a crowdfunding campaign, where private investors can put in as little as £20. The trust is being launched by former Investment Association (IA) head Daniel Godfrey, and will be a multi-manager fund of five to 10 managers. Three of these will be Asian and emerging markets specialist First State Investments, Orbis Investments and Big Issue Invest, which invests in social enterprises and charities.

You can see more details on this and an interview with Daniel Godfrey in FT Money on 29 October.

Fees: not always competitive but performance compensates

For years, one of the arguments cited in favour of investment trusts was that they typically had lower fees than open-ended funds, because the latter paid commission to financial advisers. However, since 1 January 2013 commission payments to independent financial advisers (IFAs) selling a financial product have not been allowed and funds have introduced cheaper share classes for private investors.

So while share classes of open-ended funds available to private investors typically used to have an ongoing charge of about 1.6 per cent, now you can access them for an ongoing charge of around 0.75 per cent, and almost always under 1 per cent. Consequently, investment trusts don't seem as cheap - especially as a number of them levy a performance fee - something virtually unheard of among open-ended funds outside the Targeted Absolute Return sector.

This has been confirmed by two studies: in August we reported that wealth manager Tilney Bestinvest identified 47 pairs of funds and investment trusts with similar investment strategies run by the same teams, and found that in 53 per cent of cases the open-ended funds had lower ongoing charges than the investment trusts.

More recently a report by Mr Brierley found that out of 51 comparable investment trusts and open-ended funds only 45 per cent of trusts had lower ongoing charges.

The most expensive investment companies relative to the cheapest share classes of comparable open-ended funds included:

Jupiter Green (JGC) which is 0.81 per cent more expensive than Jupiter Ecology (GB00B4KLC262),

Threadneedle UK Select Trust (UKT) 0.58 per cent more than Threadneedle UK Select Fund (GB00B8374670),

Aberdeen Japan Investment Trust (AJIT) 0.48 per cent more than Aberdeen Japan Equity (GB0004521737),

Jupiter UK Growth Investment Trust (JUKG) 0.42 per cent more than Jupiter UK Growth Fund (GB00B54CH949), and

JPMorgan Global Emerging Markets Income Trust (JEMI) 0.42 per cent more than JPMorgan Emerging Markets Income (GB00B5M5KY18).

"Old and deeply ingrained generalised assumptions about different investment structures need to be fundamentally revisited given developments in the investment industry in recent years, which has seen the removal of adviser commission from open-ended funds, bringing down their costs dramatically," says Jason Hollands, managing director at Tilney Bestinvest. "With fund costs now often lower than those of similar investment trusts and the additional competitive challenge from the rapidly innovating exchange traded funds (ETF) industry, investors need to be more agnostic over which structures to use, considering all the relevant options on a case-by-case basis."

Mr Brierley adds: "It is imperative for investment trust boards to realise and make sure that trusts remain competitive. You can't just compare the fees with those of other investment trusts - you need to be aware of other funds."

We dropped two investment trusts from our IC Top 100 Funds and replaced them with their open-ended equivalents because of a high fee differential. Baillie Gifford Shin Nippon (BGS) was replaced with Baillie Gifford Japanese Smaller Companies (GB0006014921) and Jupiter European Opportunities (JEO) with Jupiter European (GB00B5STJW84).

However, trusts still generally perform better. "We found that a large majority of investment companies have outperformed comparable open-ended funds (using an institutional investor fee) and benchmarks during the five years to 30 September 2016," says Mr Brierley. "The study looks at what fee experience retail investors will get moving forward - and investment trusts are generally outperforming against the cheaper share classes of open-ended funds."

In terms of share price total returns, 28 out of 38 investment trusts (73.7 per cent) with a five-year record included in this study outperformed. The trusts with the most notable annualised share price total return outperformance against a comparable open-ended fund include:

Baillie Gifford Japan Trust (BGFD) - 6.7 per cent more than Baillie Gifford Japanese (GB0006011133),

Impax Environmental Markets (IEM) - 5.1 per cent more than Impax Environmental Markets (IE00B04R3307),

Baillie Gifford Shin Nippon - 4.9 per cent more than Baillie Gifford Japanese Smaller Companies, and

Henderson Smaller Companies Investment Trust (HSL) - 3.5 per cent more than Henderson Smaller Companies Fund (GB0007447625).

Henderson Smaller Companies Investment Trust has a lower ongoing charge of 0.44 per cent than Henderson Smaller Companies fund's 0.84 per cent, and Impax Environmental Markets investment trust's 1.11 per cent ongoing charge is lower than the equivalent fund's 1.32 per cent.

But Mr Brierley says that a key reason for the trusts' outperformance is their managers' ability to take a long-term investment view and wait for assets with long-run potential to come to fruition, because they do not have to meet investor redemptions. The other main reason is gearing - the ability to take on debt to invest - which is beneficial when the prices of assets are going up.

"Looking forward, we expect inherent competitive advantages of the closed-end structure to continue to underpin superior long-term returns," says Mr Brierley.

However, gearing can also exacerbate losses when asset prices are going down, and performance is a measure of the past that is not guaranteed going forward. But costs are a certainty, so it is still important to try to get the exposure you need in a cost-effective way.

See also:

UK equity income trusts: best protected payouts

Two investment trust portfolios for income: one year on

Around the world in eight investment trusts

Platforms vs share schemes: the best way to buy an investment trust

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