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Top trusts

The investment trust industry continues to innovate. But is there room for improvement?
Top trusts

Some may say this year's dramas at giant global investment trust Alliance Trust (ATST) are symptomatic of all that is wrong with investment trusts. Chronic underperformance for years meant the trust's board came under pressure from activist shareholder Elliott Associates to make some drastic changes.

Alliance Trust held out as long as it was able to but earlier this month caved in, agreeing to cut costs, introduce a benchmark and target a single-digit discount. High-profile chief executive Katherine Garrett-Cox is also to step down from its board. These changes will be implemented by 1 March 2016.

However, Alliance Trust is a special case and elsewhere in the investment trust industry modernised practices, innovative fee structures and proactive boards are emerging.

The majority of investment trusts and investment companies invest in equity strategies that also exist in the open-ended funds sector and some even have mirror open-ended funds run by the same managers.

By contrast, this year's investment trust IPOs have mostly been in illiquid alternative assets such as debt and peer-to-peer (P2P) loans where the strategies particularly suit the closed-ended structure of an investment trust. Simon White, head of investment trusts at BlackRock, says: "The managers of investment trusts don't have to invest with unpredictable redemptions around the corner.

"Investors often had to choose between bonds and equities. Now they can choose between property, infrastructure, debt, private equity and P2P.

"£3.9bn has been raised so far to the end of September this year. Most has been in debt and alternative assets."

Meanwhile, the investment trust industry is realising that it is well suited to investors taking advantage of new pension freedoms in retirement. A key strength of investment trusts is the ability to reserve income for leaner years - they can retain up to 15 per cent of income per year in order to smooth out payments. Mr White says: "Most income investment trust managers managed to retain income payments by drawing on reserves in 2008 and 2009. This gives much greater certainty of income. Lots of investment trusts are also starting to pay quarterly dividends."

 

10 investment companies with the longest dividend track records

CompanySectorNumber of consecutive years dividend increased
City of London Investment TrustUK Equity Income49
Bankers Investment TrustGlobal48
Alliance TrustGlobal48
Caledonia InvestmentsGlobal48
F&C Global Smaller CompaniesGlobal45
Foreign & Colonial Investment TrustGlobal44
Brunner Investment TrustGlobal43
JPMorgan Claverhouse Investment TrustUK Equity Income42
Murray IncomeUK Equity Income42
Witan Investment TrustGlobal40

Source: AIC, as at 12 October 2015.

 

Analysts at Stifel have identified 18 trusts investing in equities that have a dividend yield in excess of 4 per cent (see table below). For those prepared to take equity risk these may be attractive in this low interest rate environment. In addition, the property, infrastructure, renewable energy and debt fund sectors also continue to offer attractive yields.

 

Highest yielding equity trusts

CompanyDividend yield %Premium or discount to NAV %
BlackRock World Mining8.8-4.6
BlackRock Latin American6.8-10.5
Henderson Far East Income6.45.5
Merchants Trust5.5-2.2
Murray International 5.41.7
JPMorgan Global Emerging Income5.2-2.1
Aberdeen Asian Income5.1-2.1
European Assets5.11.8
Henderson High Income5.03.1
Dunedin Income Growth4.7-3.8
Murray Income4.7-5.6
Scottish American4.34.1
Schroder Oriental Income4.23.1
JPMorgan Russian4.1-10.7
Invesco Perpetual UK Smaller Companies4.0-4.2
BlackRock Frontiers4.0-2.7
City of London IT4.02.4
Schroder Income Growth4.0-3.1

Source: Stifel, as at 20 October 2015

 

Good practice

Andrew Summers, head of fund research at Investec Wealth & Investment, says: "The investment trust sector probably does need to up its game.

"New players have brought innovative fee structures, sensible control mechanisms and good boards of directors.

"However, lots of incumbents need to raise their game."

The independent board of directors overseeing an investment trust is often seen as a major advantage over open-ended funds. But you need those board directors to be proactive. Mr Summer says: "There are still too many examples of boards accepting mediocre performance and having too cushy relationships with fund houses - it is rare for a board to fire a fund house.

"However, things are slowly changing. Boards are being refreshed with young blood - and are coming up with more imaginative ways to raise the share price.

"Investors are becoming more active, too - for example, in corporate governance. And we've also seen directors taking remuneration in shares."

 

 

Mr White says: "In the past year some very large trusts have made radical changes, for example British Assets appointing BlackRock as manager."

In February, shareholders of what used to be known as British Assets Trust voted overwhelmingly in favour of a radical change of investment strategy for the investment trust, which was consequently renamed BlackRock Income Strategies Trust (BIST). The trust had previously underperformed its hybrid benchmark over one, three and five years, as well as its peer sector average over three and five years.

Mr Summers cites Neil Woodford's investment trust launch as an example of good practice on fees. Earlier this year, the star manager raised £800m at launch for his Woodford Patient Capital Trust (WPCT). The trust invests in early-growth companies, typically quoted; and quoted and unquoted early-stage companies, which are expected to have a "significant exposure to medical science".

However, instead of charging an annual management fee, the investment trust will earn a performance fee, which will be payable in ordinary shares, and which Woodford Investment Management believes will further align its interests with shareholders'. "Neil can afford not to take a management fee, just a performance fee," says Mr Summers. "But it's a good example."

It also bucks the trend a little. "Performance fees used to be seen as an advantage for the investment trust sector," says Mr Summers. "But it is very hard to find the balance between simplicity and fairness. Now the investment trust sector is going for simple and transparent."

This may be because the low-cost advantage of investment trusts has diminished since commission for intermediaries is no longer built into open-ended funds. Mr White says: "The industry has responded to clean share classes on open-ended funds. Some investment trusts have cut fees or removed performance fees."

 

10 lowest cost investment companies

CompanyAIC sectorOngoing charge %
BACITGlobal0.24
BlueCrest BlueTrendHedge Funds0.24
New IndiaCountry Specialists: Asia Pacific0.30
Aberdeen UK TrackerUK All Companies0.32
Independent Investment TrustGlobal0.36
City of LondonUK Equity Income0.44
Law Debenture CorporationGlobal0.46
BankersGlobal0.48
Scottish MortgageGlobal0.48
Temple BarUK Equity Income0.48

Source: Morningstar as at 9 October 2015.

 

Four ways to use investment trusts

Simon White, head of investment trusts, at BlackRock, has come up with four ways for investors to think about how to use investment trusts in their portfolios:

Core

• Many well established global investment trusts

• Gives access to diversified portfolio

• Long-term, consistent track record

Satellite

• Investment trusts suited to specialist strategies

• Structure makes it easy to invest in illiquid assets, such as infrastructure, mining, smaller companies

Income

• Investment trusts can build up income reserves

• Only have to distribute 85 per cent

• Can boost income payments during bad times

• Capability to use covered call writing

Growth

• Fixed amount of assets = long-term growth focus

• Don't need to sell assets to manage unexpected redemptions

• Gearing can increase growth in rising markets

 

Premiums and discounts

Investors say that dealing with premiums and discounts to a trust's underlying net asset value (NAV) is one of the most confusing issues when investing in investment trusts. The basic idea is to buy into a trust when it is at a discount and sell at a premium to maximise the investment. However, it's not always so straightforward and you have to look carefully at the underlying assets to make the call. Some trusts might be worth buying at a premium, as we detail in this week's City of London Investment Trust (CTY) 'buy' tip.

In the infrastructure sector, where trusts are trading at particularly high premiums, some analysts say the net asset values may be understated and the premiums might go down if the investment trusts were valued differently. Infrastructure trusts calculate a 'discount rate', which takes into account government bond yields and a risk premium on the assets. Low government bond yields mean trusts have been able to increase their discount rates, increasing both projected cash flows and NAVs.

But if you hold an investment trust for the long term, a premium to NAV is not such a problem as its good returns may compensate for this over time. If you don't expect the premium on the trust to narrow any time soon because it has been fairly constant, you may also be able to sell it at a premium.

Mr Summers says: "Nobody likes buying something at a premium - it goes against your instincts. However, you can - in a low interest rate world - justify buying assets on high premiums if you think the premium will erode after your holding period. Do the maths and maybe that will justify buying it. Even obvious discount plays are unattractive if you don't think the NAV growth is going to be there."

He cites discounts in the Association of Investment Companies' hedge funds sector, such as the 5 per cent discount on BH Macro (BHMG), an IC Top 100 Fund. This trust makes very different returns to equities by investing all of its assets in the Brevan Howard Master Fund, one of the largest hedge funds in the world. This hedge fund aims to generate consistent long-term appreciation through active leveraged trading and investment on a global basis.

"The discount may look good, but if the trust is only delivering 1 per cent a year then there is a reason for the discount," he says. BH Macro delivered 1.47 per cent from 1 January to 28 August 2015 and 0.26 per cent for the 2014 calendar year.

Investors may spend a lot of time on the buy decision, but you should spend equally as much on the sell decision and set aside time to monitor the investment while you're holding it.

Reasons to sell an investment trust would include if the investment process changes or you think the company no longer has a good prospect of delivering growth. Or you might think the board of directors is not motivated enough to monitor performance.

But scrutinise performance carefully and in line with your own appetite for risk. An investment trust that matches its benchmark with lower volatility might be more attractive than an investment trust that slightly outperforms the benchmark with higher volatility.

Mr Summers says: "US equity income trusts have underperformed the S&P 500 index over the past few years. This is because the best performing stocks in the S&P were ones that didn't pay a dividend. If those trusts had outperformed the benchmark it would have been worrying. I would have been more worried if they had stopped paying my elderly client the 4 per cent income that she needs to live on."

 

Five AIC sectors on highest premiums

AIC sectorPremium %
Sector Specialist: Infrastructure10.2
Property Direct - UK5.0
Sector Specialist: Infrastructure - Renewable Energy3.4
Sector Specialist: Debt0.2
Global Equity Income0.0

 

Five AIC sectors on highest discounts

AIC sectorDiscount %
Private Equity*-21.6
Property Direct - Asia Pacific-19.7
Country Specialists: Asia Pacific-15.8
North American Smaller Companies-15.5
Sector Specialist: Commodities & Natural Resources-14.1

Source: AIC using Morningstar, as at 30 September 2015.  *Private equity figure excludes 3i.

See also:

Investment Trusts: The professional picks 2015

Two investment trust portfolios for income

Making better use of global trusts

Around the world in 8 investment trusts

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