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IT geek: look beyond the sector definition

Investment trusts' allocations may not always reflect the sector they are ranked in

Investment trusts are ranked in sectors by the Association of Investment Companies (AIC). Putting similar funds into sectors can help to find a certain type of fund, for example one focused on Asian equities. And you can then compare it against similar funds to see if you could do better by investing in another one.

However, while AIC sectors usually provide a good way of choosing and assessing investment trusts, there are some exceptions, which means you should compare a trust to more than its peers and average, and look at its credentials very carefully before you invest in it.

A number of trusts' asset allocations might not be what you expect in view of the sector they are ranked in. Examples include Law Debenture Corporation (LWDB), which has over 70 per cent of its assets in the UK despite being ranked in the Global sector, and compares itself to the FTSE All-Share, in which many of its largest investments are included. This is in line with the AIC's definition of the sector, which includes trusts "whose objective is to produce a total return to shareholders from capital growth and some dividend income. They will have less than 80 per cent of their assets in any one geographical area".

Law Debenture has less UK exposure than a UK fund, but is less geographically diversified than other Global funds. So if you invest in this trust, which has an excellent long-term track record, count it as part of your UK rather than overseas equity allocation.

The Global Smaller Companies sector, meanwhile, only has three trusts in it and one of these, Marwyn Value Investors (MVI), currently has a majority of its assets listed in the UK.

Again this is in line with its sector definition, which includes trusts "which invest at least 80 per cent of their assets in smaller company securities. They will have less than 80 per cent of their assets in any one geographical area".

Woodford Patient Capital Trust (WPCT) is ranked in the AIC UK All Companies sector, but has around half its assets in unlisted companies and over 60 per cent in healthcare, making it more like a specialist sector fund rather than its sector peers. 

When you get a sector with a particularly large trust it will skew the sector average figures. Examples include Scottish Mortgage Investment Trust (SMT) with assets of over £6.7bn in the Global sector, Murray International Trust (MYI) in the Global Equity Income sector with assets of £1.6bn and 3i Group (III) with assets of over £7.6bn in the Private Equity sector. "You need to be aware of the distortions in the average, so look at the factsheet and check the benchmark and other aspects of the trust before investing," says David Liddell, chief executive of online investment service IpsoFacto Investor.

In the country specialist sectors you get trusts focused on different countries, eg China and India in Country Specialists: Asia Pacific. These are not comparable to each other and the sector average is not relevant. However, if there are trusts focused on the same country within the sector, for example India, then it would be relevant to compare them with each other, and not just in terms of their performance. Look at their ongoing charge, size, discount or premium to net asset value (NAV), and level of gearing as well. And compare them to broad regional benchmarks and open-ended funds invested in the same areas. 

The Flexible Investment sector is for trusts "whose policy allows them to invest in a range of asset types". It comprises a fairly diverse range of trusts with fairly different allocations and objectives to each other.

Some Flexible Investment sector trusts take a wealth preservation approach, for example, Capital Gearing (CGT) and Personal Assets (PNL). F&C Managed Portfolio Trust Growth (FMPG), meanwhile, aims "to provide… capital growth from a diversified portfolio of investment companies. [It] invests in a diversified portfolio of at least 25 investment companies that have underlying investment exposures across a range of geographic regions and sectors, and the focus of which is to maximise total returns, principally through capital growth."

So again, the sector average returns are probably not relevant and you are better comparing these trusts with similar funds and appropriate benchmarks. Similarly Sector Specialist: Debt trusts invest in various different types of debt and have different objectives, so comparing them with each other is not necessarily appropriate.

There are two main types of fund in the Private Equity sector: those that invest directly in unlisted companies and those that invest in other private equity funds. Private equity funds of funds are typically lower risk because they have exposure to hundreds or thousands of investments rather than under a 100. Directly investing private equity investment trusts can have a high concentration of investments, so if one goes wrong it could have a significant impact on returns. However, funds of funds do not get as much uplift from a single realisation as a directly investing fund.

Funds of funds can have higher charges because they involve a double layer of fees: at the trust level and on the underlying funds. If you are thinking of putting your money into a private equity trust it is very important that you understand what type it is because of the risk differences. 

It is also more relevant to compare the returns of a fund of funds to other funds of funds, and a directly investing one to others that do this. For this reason, in its data broker Winterflood splits private equity trusts into three categories: direct, fund of funds and managed wind-down.   

Even the larger AIC sectors are smaller than their open-ended equivalents. For example, the AIC Global sector has 22 trusts but the IA Global sector has 280, and the AIC UK All Companies sector has 15 while the IA UK All Companies sector has 249. In such cases it is worth looking at the performance of the trusts against their open-ended peers, to really see what the best active option is in these spaces. If any of these are performing better and have lower charges they may be a better option. 

When doing this Mr Liddell suggests comparing a trust's NAV rather than share price performance to open-ended funds, as this is what the trust's portfolio is doing so is a better comparison with an unlisted fund. He says to also bear in mind that if a trust has gearing (debt) it is also likely to outperform ungeared funds in rising markets and underperform them in falling markets.

Also look at how a trust compares with broader benchmarks for the region because if it consistently underperforms a passive fund tracking one of these, it might be better. But in this case make sure you have the necessary risk appetite as broader indices may be more volatile and higher risk.