Investment trusts have long been called the City of London’s best kept investment secret. This is for two reasons. The £249bn investment trust industry is dwarfed by the open-ended funds business, worth £1.5tn as at the end of May. Why such a difference? Because funds have been sold to investors by an army of salesmen known as Independent Financial Advisers. Investment trusts, on the other hand, have relied up being ‘discovered’ by savvy investors prepared to seek out and understand them. But once discovered, their features and benefits seem to make for a loyal and growing fan-base. We look at some of these features, and why they are driving record numbers.
Investment trusts do have one feature not commonly used by funds that makes them more risky. They can borrow money to invest. The idea is that the fund manager uses their skill and judgement to use the borrowed money to generate a return higher than the cost of borrowing the money in the first place. Get it right and it applies a multiplier effect to gains. Get it wrong, and the same is also true of losses.
But investment trusts also come with another feature which is useful for those investors seeking a stable income. This is the revenue reserve. All this means is that fund managers can squirrel away some of the income (dividends) they receive for use in the future. They can dip into their reserves when times are hard (like during a global pandemic) so investors don’t see their income drop.
Open-ended funds are compelled to pay out all the dividends they get in any particular year. This means payments to investors in that fund can see-saw from one year to the next.
Investment trusts’ special sauce
There’s one more feature that make investment trusts a useful investment vehicle for certain types of investment. Once you launch one, the number of shares in issue generally stays the same from day to day. So if I wanted to buy shares, I’d have to find a seller through an exchange. The investment trust manager does not need to worry about this at all.
Funds, on the other hand, grow and shrink every day as people leave and new people arrive. This means an open-ended fund manager needs to hold some cash to be able to pay back that day’s leavers. As the recent issues with Woodford Equity Income and various property funds has shown, they also need to be able to sell assets in the fund quickly if lots of investors want their money back at the same time.
All of this makes investment trusts ideal for holding assets that aren’t easy to sell – like property.
New records set
And so it’s a confluence of these three factors that means investment trusts are seeing record numbers. Better performance, stable income and the ability to safely hold hard-to-sell assets are all in demand. So much so that a total of £6.3bn was raised by them in the first half of 2021. This is the highest amount ever in a half-year period according to the Association of Investment Companies (AIC).
This comes from a combination of existing companies raising more money, and new investment trust launches. £5.1bn was raised by existing investment companies. The Renewable Energy Infrastructure sector (a group of like investment trusts) raised the most at £883m, followed by Growth Capital (£803m) and Infrastructure (£475m).
The largest fundraisings by existing investment companies were completed by Schiehallion (£503m) in the Growth Capital sector, Smithson (£307m) in the Global Smaller Companies sector and Chrysalis Investments (£300m) in the Growth Capital Sector.
New investment trust launches totalled £1.2bn, which is the highest since the first half of 2017. These included Cordiant Digital Infrastructure, VH Global Sustainable Energy Opportunities and Taylor Maritime Investments.
Something for everyone
There is much to celebrate here. The investment trust sector is a vibrant and diverse one with some investment opportunities that launched over 150 years ago still going strong (see F&C Investment Trust) sitting cheek by jowl with brand new innovative ideas like digital infrastructure. With just shy of 400 investment trusts to choose from, there is more than enough to go at for most investors.
But inexperienced investors should make sure they know what they are getting themselves in for. Some of these smaller, more esoteric investment trusts will have higher charges, and their prices will move dramatically, and they may pay little or no income.
But without risk, there is no return, so check these things out, and enjoy the ride.