How advisers can use investment trusts

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.”

All change?

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.

Trading costs

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.”

eleanor.duncan@ft.com