Will regulation boost investment trusts?

Since 1 January 2013, commission payments to financial advisers selling a financial product have not been allowed, following the financial regulator's Retail Distribution Review (RDR). Previously, if you went to a commission-taking adviser you got what seemed like free advice, but it was actually being paid for via commission paid to the adviser. Read more on this

This only applied to products that paid commission, such as unit trusts and open-ended investment companies (Oeics) - investment trusts and exchange traded funds, for example, did not pay commission.

This change theoretically puts investment trusts on a level playing field with unit trusts and Oeics in terms of adviser preference, especially as the regulator also says that independent financial advisers (IFAs) should have to consider products across the market.

As a self-directed investor, you may be wondering why this should be of any interest to you as you do not rely on an IFA's recommendations. But at the end of 2012 (according to the regulator) there were 30,045 fully qualified investment advisers. If more of these start using investment trusts and the shares of these funds are in greater demand, discounts could tighten and share prices could rise, benefiting trusts' shareholders.

It is also anticipated that some investors who once used an IFA will no longer do so as they have to pay an upfront fee, resulting in more self-directed investors who might also favour investment trusts.

And some IFAs who feel they cannot meet the new standards are delegating their clients' asset selection to discretionary wealth managers, who use investment trusts, providing another potential source of demand for investment trusts.

Investment trust provider Aberdeen Asset Management reported last October that it had already seen strong increases in direct platform flows by self-directed investors and from discretionary fund managers managing portfolios for IFAs.

Likely beneficiaries

Industry participants expect that some investment trusts will benefit from increased demand much more than others. A recent Association of Investment Companies (AIC) poll of investment trust directors found that 65 per cent believe the largest and most liquid investment companies will be the most likely beneficiaries of RDR over the longer term.

"Obvious winners should include the large, well-managed and low-cost generalist investment trusts," says Nick Sketch, senior investment director, Investec Wealth & Investment. "These offer a good one-stop shop for mainstream equity exposure, sometimes with a bias to defensiveness or income generation. These will probably be particularly suitable for smaller investors of the sort who would last year have been steered firmly toward open-ended choices.

"Decent examples should include Foreign & Colonial Investment Trust (FRCL), Bankers Investment Trust (BNKR) and Witan (WTAN), but also slightly less generalist choices like (IC Top 100 Funds) RIT Capital (RCP), Personal Assets (PNL) and Ruffer (RICA). The UK Equity Income investment trusts like City of London (CTY) and Perpetual Income & Growth (PLI) may also find new supporters.

Other winners may include investments that have sister unit trusts or open-ended investment companies (Oeics) with the same manager and approach, but higher total costs, where we may well see more switching."

Examples include (IC Top 100 Fund) Edinburgh Investment Trust (EDIN) run by Neil Woodford with an ongoing charge of 0.72 per cent, in contrast to Invesco Perpetual Income (GB0033053827) and High Income (GB0033054015), which currently have total expense ratios of 1.68 per cent and 1.69 per cent, respectively.

Scottish Investment Trust (SCIN) with a market cap of £619m and Temple Bar (TMPL) with a £690m market cap are also examples of trusts with the ability to handle larger daily trading volumes, according to John Newlands, head of investment companies research at Brewin Dolphin.

Alliance Trust (ATST), meanwhile, could benefit from RDR, not just because it is a large and liquid global growth trust, but because it operates the Alliance Trust Savings (ATS) investment platform. A rise in self-directed investors would benefit ATS which, unlike some platforms, will not suffer from the recent HM Revenue & Customs ruling that cash rebates by fund platforms to customers are taxable, as ATS only offers commission-free share classes.

Read more on this

The Financial Conduct Authority (FCA) has decided that from April next year platforms will have to stop taking commissions from product providers, and instead charge investors for using their platform service, but this also will not affect Alliance Trust’s existing business model.

While some of these global growth trusts are not at the top of their sector performance tables, their long-term total returns are good, and they may appeal to new self-directed investors who do not want anything too complicated.

Read more on Best trusts for global growth

Meanwhile, James Frost, marketing director at Witan, reports increased interest in the Witan Pacific (WPC) investment trust. "Whether this is RDR or just because of an interest in Japan is unclear," he says. "But we have had more IFA platforms such as Accenture and Raymond James showing an interest. It is early days but quite encouraging.

"Online brokers have been long-term supporters, but the rate of buying has increased over the past six to seven months. But this could be because markets have been motoring ahead."

The AIC adds that it has anecdotal feedback suggesting that advisers are not just interested in the largest, most liquid funds.

"We've seen a fair amount of interest in these generalist companies, but advisers are also interested in the more specialist alternative asset classes like private equity, property and infrastructure," says Ian Sayers, director-general of the AIC. "Advisers are aware that they need to demonstrate value to their clients and these alternative asset classes are a way of doing this."

Global growth trusts

Source: Morningstar

Performance data as at 26 April 2013

UK Growth and Income trusts

Source: Morningstar

Performance data as at 26 April 2013

No immediate effect

However, IFAs may still not necessarily consider investment trusts for their shareholders, for example if they categorise their clients as too cautious to invest in a listed fund with gearing.

Discounts on investment trusts have tightened this year, but this is not necessarily attributable to RDR. "The performance of the market this year probably had a good effect on investment trust discounts," says Simon Elliott, head of research at market maker Winterflood Securities. "But, over time, increased investor interest in investment trusts could have a very powerful effect."

Many feel that it is too early to tell whether IFAs are increasing their purchases of investment trusts.

"We are seeing an uplift via the non-execution-only services but are not sure this is down to RDR," says Sarah Gibbons-Cook, investor relations & PR manager, investment trusts at Henderson. "It might be more to do with the uplift in equity markets."

"There is definitely more of an interest in investment trusts from the intermediary sector, but this is not translating into a huge amount of business yet," says Simon Cordery, head of investor relations for investment trusts at F&C Investments. "We will not have a good picture until there is at least a full year of business. But what we have noticed over the past year is the increased level of requests for information and training from IFAs: in the past six months we have done more seminars than for ages. So the desire for education has gone up, and hopefully that will translate into demand."

He also says the number of self-directed investors on investment trust share registers has gone up, but this was happening before the introduction of RDR in January 2013.

The three main IFA investment platforms, Cofunds, Scandia and Funds Network, do not currently host investment trusts, although IFAs could use more than one platform to get the full range of investments they want. And the FCA's recent ruling that rebates on new business will be banned from April 2014 "will also encourage platforms to hold a broader range of investment products, including investment companies, which have not paid for access in the past," according to Mr Sayers.

RDR also means that charges on unit trusts and Oeics are falling sharply as they no longer need to pay trail commission, which should eventually erode one of the advantages claimed for investment trusts. At present, more than 50 per cent of investment trusts levy a performance fee, which puts off some IFAs, says Mr Newlands.

And where an investment trust with a similar open-ended mirror fund trades at a premium to net asset value (NAV), the open-ended version may be favoured.

But many investment trusts still have low charges, even with performance fees, while some such as Fidelity China Special Situations and four Baillie Gifford trusts have recently cut their fees. Read more on this

"Those looking for a quick rerating (as a result of RDR) in most investment trusts, may well be disappointed," says Mr Sketch. "Few of these investment trusts trade at wide discounts today, and most will be happy to issue new shares if they move to a premium rating. Instead, new buyers are more likely to get a benefit from the longer-term investment approach and the incremental effect of slightly lower total costs every year."

So you probably shouldn't position yourself in a trust just because you think it will benefit from RDR.

"As strategies go, I'd be a bit sceptical," says Mr Elliott. "If you think an investment trust looks interesting for other reasons as well as the fact that it might benefit from RDR then fine. But just investing because of the possible effects of RDR is a bit too far."