How advisers can use investment trusts
The five main objections advisers have to investment trusts and how to overcome them
The first investment trust was launched 150 years ago yet they still remain an unfamiliar investment vehicle to many advisers.
The perceived complexity of closed-ended funds is often cited as a barrier, while limited access on platforms has been another hurdle for the investment trust industry to overcome.
But there are signs this is changing.
Adviser purchases of investment trusts reached a record high in 2017, as reported by the Association of Investment Companies (AIC)
And more investment platforms than ever before are offering trusts alongside open-ended funds.
The ability investment trusts have to deliver consistent and growing income has been another selling point in recent years.
Nick Britton, head of training at the Association of Investment Companies, observes investment trusts are gaining an equal footing.
"Encouragingly, we’re seeing an increasing number of firms adopt a more agnostic approach to investing, putting investment trusts on a level playing field with open-ended funds, ETFs and other investments.
"This can only benefit the client, as well as stimulating competition between types of fund, raising standards across the board.”
Schroders' head of investment trust sales, John Spedding, urges: "It is now essential that investment trust managers work with advisers to highlight the usefulness of conventional investment trusts in client portfolios, while debunking some of the main objections to the structure."
This report aims to bust five of the biggest myths about investment trusts.
Ellie Duncan is deputy content plus editor at FTAdviser
Advisers still dodging 'hard to explain' investment trusts
Investment trusts are “hard to explain”, financial advisers have said.
When asked what the main reason was for not recommending them to clients, complexity was given as the main answer.
According to the latest FTAdviser Talking Point poll, which surveyed advisers for their main objections to using investment trusts, 40 per cent reasoned they were difficult to explain to clients.
But John Dance, chief executive at discretionary fund manager Vertem Asset Management, said that was "a bit of a lazy reason".
"There are certainly more complex products out there than an investment trust," he added.
Mr Dance explained: "We use them sparingly. We use them for illiquid or less liquid asset classes. Where we've found them as being the best vehicle for [accessing] asset classes is typically for things such as infrastructure."
He explained: "If they [less liquid asset classes] are owned in an open-ended fund, and you get a big redemption, they’re not exactly positions that are easily unwound. So to have them in a closed-ended vehicle obviously means the manager can concentrate on managing the portfolio."
In response to the poll on Twitter, Claire Markham, a chartered financial planner at FH Manning Financial Services, said she also used investment trusts in client portfolios “for more illiquid asset classes”.
The poll results showed 28 per cent also cited availability on platforms as they reason they did not invest in investment trusts, closely followed by 27 per cent who said they preferred open-ended funds.
David Bebb, chartered financial planner at Upfront Financial Services, said he was reluctant to use investment trusts over Oeic equivalents in client portfolios due to the additional trading costs incurred.
"Oeics/unit trusts can often be bought and sold with no initial charge via an investment platform," he noted.
"Investment trusts typically incur dealing charges, which is unhelpful, particularly if the client is making regular contributions, or the client is in the decumulation stage and needs to 'sell-down' from their investment on a regular basis."
Investment trusts are now more widely available on platforms, with only two platforms yet to add them – Cofunds and Old Mutual.
Mr Dance agreed availability of closed-ended funds on platforms was one of the reasons advisers did not use them so often.
"They’re more of a staple within many DFM portfolios and a lot of our peer group are quite happy using them," he acknowledged.
"But access to them for advisers has been very difficult. The consolidated trading process that platforms have typically used has made it difficult for them to offer them to advisers.
"We access a few platforms to manage model portfolios for IFAs and that side of the market is definitely opening up and now becoming more available on a number of platforms."
While some financial advisers have remained hesitant about the investment trust structure, the Association of Investment Companies (AIC) reported purchases of investment trusts by advisers and wealth managers reached a record £990m in 2017.
It revealed in a press release last month (March) that this figure was up 46 per cent on £679m in 2016 and 41 per cent higher than the previous record of £704m in 2015.
Ian Sayers, chief executive of the AIC, explained: “Advisers are recommending investment companies due to their strong long-term performance and dividend record, innovation through new asset classes and the durability of the investment company structure.”
Rebecca O’Keeffe, head of investments at Interactive Investor, said: “Overall, where investment trusts exist in parallel with an open-ended fund it is essential that investors check the performance of both to see which one has the better track record.
“Investors who consider themselves to be purely ‘fund investors’ may be missing a trick by not expanding their horizons and looking at the range of available investment trust options, but equally investment trust fans should also keep their options open too.”
Only 5 per cent of those who voted in the poll claimed the split-cap crisis, which was investigated by the financial services regulator in 2002, was the reason they do not recommend closed-ended funds to clients.
The five main reservations advisers have about investment trusts and how they can overcome them
Investment trusts are the Marmite of the financial services product world.
Some financial advisers 'love 'em', using them in client portfolios to access some of the more illiquid asset classes or to deliver the steady income required by clients.
Other advisers 'hate 'em', often because of the complexity of explaining the investment trust structure, or due to their lack of availability on some of the major platforms.
Of course, advisers have a wide range of products at their disposal to use in client portfolios.
While advisers certainly cannot be experts on every financial product, it may help to understand how some perceptions about closed-ended funds can be overcome so that investment trusts are an option for their clients.
This year marks 150 years since the first investment trust launched.
There must be a reason why these investment vehicles have stood the test of time.
One of the biggest objections to investment trusts, and the one which came top in the FTAdviser Talking Point poll, was that some of the intricacies of trusts are hard to explain to clients.
Concepts such as discounts and premiums, are commonly brought up as challenging to put across to retail investors.
John Spedding, head of investment trust sales at Schroders, explains: “Perceived complexities had previously led to investment trusts becoming less popular with some advisers, although there are signs that this is changing post-RDR.
“Some of the main objections raised by advisers include the potential for discount/premium volatility, fears over liquidity, gearing amplifying losses and a lack of understanding about the role of the board.”
He acknowledges that the difficulty in explaining these technicalities to clients is often cited by advisers reluctant to recommend investment trusts.
Alex Denny, head of investment trusts at Fidelity, says the perception of these vehicles as complex and difficult to understand is “perhaps unfair”.
“Some advisers have said that they shy away from investment companies as they dread explaining the discount/premium mechanism to clients,” he notes.
Knowledge at their fingertips
But he suggests: “This is something that’s been changing, with investment houses like Fidelity, as well as the Association of Investment Companies [AIC], doing much more to produce educational materials and provide the cogs and wheels of how trusts work.”
Nick Britton is head of training at the AIC, and has been running workshops and roadshows to help educate advisers about investment trusts.
“The fact that investment trusts trade at discounts and premiums, and can use gearing, make them different from other funds,” he admits.
“Much of our adviser training revolves around these less familiar areas, aiming to provide practical tips on how to deal with them and address any concerns head-on.”
But he observes among the other reasons advisers do not use investment trusts has more to do with the nature of the adviser’s business or investment approach.
“They may outsource investment decisions to discretionary fund managers who don’t use investment companies, or adopt a passives-only approach,” he points out.
Another of the main objections, historically, has been a lack of platforms offering investment trusts.
Mr Denny recognises one of the most frequently cited points of frustration by advisers in the past has been the challenge of getting access to investment trusts via platforms.
“Until relatively recently, a number of the most popular platforms used by the adviser community simply didn’t offer investment trusts – or indeed any real single security capabilities,” he points out.
“With many advisers servicing clients on more than one platform, there was an inevitable bias towards holding ‘common denominator’ funds or securities – so even on platforms where investment trusts were an option, they were often underused.
“With platforms expanding and enhancing their propositions, the opportunity set has broadened significantly and it’s no surprise that we see advisers keen to capitalise on this.”
Mr Spedding asserts: “There still isn’t enough access on the main platforms and that continues to present a barrier to widespread adoption.”
But Mr Britton refers to some promising figures, which show 17 out of 19 major adviser platforms allow trusts to be purchased.
“Of these 17, all but two allow trusts to be included in model portfolios too,” he notes.
Now, only two platforms – Cofunds, which has been bought by Aegon, and Old Mutual – do not offer closed-ended funds alongside open-ended funds.
“Since Cofunds’ acquisition by Aegon, we understand that Cofunds customers will be offered investment trusts in the future. We hope Old Mutual will follow suit,” Mr Britton says.
“These will be important steps in expanding access to investment trusts, but in reality, many advisers are using more than one platform to meet the needs of different clients.”
Costs and charges in investment management are coming under increased scrutiny by the regulator.
Active managers are already feeling the pinch as passive providers continually lower ongoing charges, making it difficult to compete.
For some advisers, the charges associated with investment trusts have so far prevented them from recommending these products to clients.
For Steven Lloyd, investment director at Ascot Lloyd, the way charges are applied to investment trusts is one of the main reasons the firm does not use them on behalf of clients.
“The closed-ended unit cannot be broken down like an open-ended unit can.
"Therefore, clients have to buy whole units which often does not work when clients are looking to invest small amounts on a regular basis,” he explains.
“Closed-ended funds bring other trading costs that would have to be paid by the client on the way in and way out. Again, for clients looking to invest small amounts regularly, this can significantly affect performance.”
Replying to a story on FTAdviser about investment trusts, a subscriber going under the username 'Wychwood FS', suggests: “It’s interesting to see (now that we have full cost disclosure), that the actual cost of gearing can make these vehicles more expensive than their Oeic/unit trust counterparts.”
But for John Dance, chief executive at Vertem Asset Management, an investment trust trading at a discount can be an opportunity in certain situations.
He still has his reservations, however, when it comes to using closed-ended funds to get exposure to the equity market.
“There are a lot of investment trusts that are equity based, so if you’re using them to access that underlying asset type, you’re effectively doubling your market risk in many ways.
“This is because your underlying assets are subject to equity market volatility, and then you’ve got the extra volatility of the investment trust over the top of that as it swings from a small discount to a bigger discount,” he reasons.
“We typically wouldn’t use an investment trust to access an equity market, that’s for sure.
“That is, unless there had been a severe market event and the investment trust was trading at a significantly larger than normal discount and we were willing to play the long game and hopefully get a market recovery - and a recovery in the discount.”
Trusts over funds
Where investment trusts are a preferred option to their open-ended counterparts is for alternative or less liquid asset classes, such as infrastructure and property.
In March, the AIC revealed the most popular investment company sectors over the whole of 2017 were Global, accounting for 17 per cent of purchases, Property Direct – UK, which made up 11 per cent, UK Equity Income, with 10 per cent of purchases, Debt at 7 per cent, Infrastructure at 6 per cent and Property Specialist, also accounting for 6 per cent.
Ian Sayers, chief executive of the AIC, says: “It’s significant that four out of the six most popular sectors for advisers are in alternative assets generating attractive yields, and two of these sectors are property.
“Since the problems experienced by most open-ended property funds after the referendum [on EU membership], property investment companies have grown in popularity.
“Advisers are clearly recognising the suitability of the closed-ended investment company structure for illiquid assets.”
Generally, adviser purchases of investment trusts has been growing, as Mr Britton observes.
“The use of investment trusts by advisers has increased markedly since RDR, with almost £1bn of purchases on advised platforms in 2017, compared with £219m in 2012.
“However, it’s fair to say that most advisers still do not use investment trusts with clients,” he remarks.
What can the industry do to help improve the barriers to wider take-up of investment trusts?
Plenty is already being done, with lots of information now available on how closed-ended funds work and how they differ from open-ended funds.
More major platforms are making investment trusts available to discretionary fund managers and advisers.
Transparency of costs and charges is improving, while some investment trusts continue to clock up decades of dividend payouts to investors.
Mr Spedding suggests: “To overcome these barriers, it is important for investment trust managers to provide advisers with appropriate information and to give them the means to inform their clients of both the benefits and the risks.”
He calls for more comprehensive educational materials and more detailed information to help overcome some reservations.
“Better opportunities for advisers to interact with key trust stakeholders, broadening trust representation on platforms and greater sector innovation would also be beneficial,” he adds.
The right time
Mr Britton of the AIC acknowledges investment trusts will not be for everyone.
“Our message is that investment trusts will be right for certain clients in certain circumstances,” he notes.
“They are particularly good at providing higher or more consistent income, growing wealth over long periods and accessing illiquid asset classes. These benefits can be demonstrated and for many advisers, they make the use of investment trusts worthwhile as part of a client’s portfolio.”
He confirms: “We’re seeing new adviser firms add investment trusts to their clients’ portfolios all the time.”
For Mr Denny, the future for investment trusts is promising, given the backdrop against which advisers and their clients are investing.
“This year was always going to be a bumpier ride than last and, anecdotally, advisers are being forced to become more ambitious in their choice of prospective investments, with the usual suspects looking less compelling,” he reasons.
“This, coupled with the fact that many IFAs have ploughed considerable resources into expanding and upskilling their research teams in a post-RDR world, has ensured the investment companies sector is being eyed for bargains ever more keenly.”
House View: John Spedding, head of investment trusts at Schroders, on why investment trusts saw a resurgence in 2017
Demand for investment trusts surged last year.
The industry still faces challenges, as the article above highlights, but the latest industry figures give hope that more investors are appreciating the benefits.
Intermediaries appear to be joining the party. Investment trust sales on adviser platforms - hit £990m in 2017.
This was 46 per cent higher than in 2016 and 41 per cent up on the previous high of £704m in 2015, according to data from the Association of Investment Companies (AIC).
This continuing demand reflects the ongoing search for income as well as buoyant markets. But it also reveals a growing appreciation of the structural advantages of investment trusts, which could contribute to superior returns over the long term.
The global funds sector garnered the most sales in 2017, accounting for 17 per cent of adviser purchases.
Sales were also particularly strong in a number of other sectors where investment trusts offer some advantages compared with more commonly held open-ended funds or unit trusts, for example in property.
The structure of investment trusts makes them potentially well-suited to investing directly in property.
Physical commercial property, such as retail, office and industrial premises, can be illiquid, meaning they can be difficult to buy and sell in a hurry.
This can create difficulties for open-ended funds when many investors try to sell at the same time. This was important in 2016, when withdrawals were restricted on open-ended property funds due to Brexit-related selling.
There were, by contrast, no withdrawal restrictions on property investment trusts.
As closed-ended funds, investment trusts have a fixed number of shares in issue. When an investor wants to sell an investment trust they have to do so via the stockmarket.
This means they are less vulnerable than open-ended funds to the risk of having to sell assets at short notice due to high levels of redemptions, although the price they obtain in the market may be less than the underlying asset value.
According to statistics from the AIC, as of 31 March 2018 the average investment trust has beaten open-ended funds over the medium and long-term.
Of course, it’s important to recognise that past performance is no guide to future performance and your capital and income is at risk.
One reason for the strong performance of investment trusts in rising markets is “gearing”. This is the ability, within limits, to borrow money to use for further investments, amplifying gains or losses.
Investment trusts commonly borrow money in order to invest in this way.
The special structure of investment trusts can allow their managers to focus on the long-term without worrying too much about short-term noise. This can be reflected in superior performance over long-term time horizons.
For those looking for income, investment trusts can offer an advantage too.
Schroder Income Growth Fund plc has increased its dividend consistently for the last 22 years, making it an interesting proposition for income-seeking investors.
It has been aided by the investment trust structure which has allowed it to retain a small portion of the income it has received in some years to pay out in others and which, in turn, has allowed for a consistent increase in dividend income to investors.
Schroders offers seven investment trusts, four of which are focused on Asia. The region’s markets have made impressive gains in the past few years and we believe there is potential for more growth.
Here we offer seven charts as to why we think this. Find out more.
We also feel that there is potential from some unloved areas of the UK market where our income and mid-cap investment trusts are invested for those patient enough to look beyond Brexit.
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