In a world that is terrifically excited about anything that sounds alternative or disruptive, the humble investment trust might look rather Victorian. But the original idea remains revolutionary. Find a bunch of great, sometimes unorthodox, investment ideas where an expert manager can add real value and then raise money to fund a company that will invest in them. Next, list shares in the company on the stock exchange and there you have it: a vehicle that can invest for the very long term, but enables its shareholders to buy in and sell out whenever they like.
If they clamour to get in, the trust’s shares will rise to a premium (meaning that their combined market value exceeds the value of the assets the trust owns); if they don’t like what they see and sell, the shares will fall to a discount (where the total asset value exceeds the market value of the shares).
Back in the Victorian era when some of the first trusts were established, this novel structure might have meant backing gold mines or railways in South America. Now it can mean putting money into assets ranging from small business loans in the UK through to frontier markets in the developing world, on the way taking in broad swathes of fairly mainstream property and global equity investments.
There are two broad types of investment trust. The best known are usually called general funds and mainly hold UK and international shares. Large funds such as Alliance Trust and Witan fit this description and are effectively one-stop shops for long-term investors seeking a basket of shares in quality, large companies with a few alternative ideas sprinkled on top. Others in this first group go for racier, new-economy businesses: one such, Scottish Mortgage, is a prolific investor in tech goliaths such as Facebook and Amazon. A few, such as Battle Against Cancer Investment Trust, are even more adventurous and invest in hedge funds and alternative fund managers, diversifying across shares, bonds and other assets. There’s even a smaller sub-group that were originally investment vehicles for wealthy families but are now open to all—the Rothschild family’s RIT Capital Partners, for example.
"The good news is an investment trust has a board that can kick out an underperforming manager"The second group of trusts are the specialists, where fund managers offer a huge range of niche opportunities, often involving alternative sources of income. The most established are the property-focused Real Estate Investment Trusts that own everything from offices and industrial units to student flats. Then there are infrastructure funds that invest alongside the government in schools, hospitals and roads. Renewable energy funds also fit into this broad category, with solar and wind farms featuring prominently. Nearly all of these pay a reasonably well-covered dividend that varies between 4 per cent and 6 per cent a year.
Sticking with the income theme there’s also a range of funds that invest in loans and other more esoteric forms of debt including Peer-to-Peer lending (P2PGI and VPC), equipment finance (SQN), project finance and infrastructure debt (Sequoia).
If income isn’t your priority, a smaller sub-set of funds aim for big capital gains by targeting riskier equities such as small companies, emerging market stocks, biotech and technology ventures. These latter funds have had a brilliant recent run although valuations look a little stretched at the moment. It’s also worth mentioning the handful of sector-specialist funds, notably racy mining and resource funds, although the share prices of some have been hugely volatile recently.
Whatever your investment priority—income or capital gains—the beauty of investment trusts is their sheer variety and specialist focus. These are ideal for the smarter investor who is willing to live with the fact that, as with any stock market investment, the shares can be volatile, swinging from premium to discount and back again. Some funds that invest in private equity once traded at premiums (the market value of their shares was higher than the value of the stakes in private businesses that they owned). But many now languish at huge discounts, leaving a small army of disgruntled investors wondering what went wrong.
Remember that markets are fickle and hot “alternative” investment ideas can fall out of fashion. Then the shares can become difficult to trade, which in practical terms means the spread between the buying and selling price can widen to 2 per cent or more. And as with any fund—listed or otherwise—be on the lookout for managers who’ve lost their mojo. The good news here though is that an investment trust has a board with independent, non-executive directors who can get stroppy and kick out an underperforming manager. Those feisty, adventurous Victorians cared about good governance, and thanks to them investment trusts tend to look after the smaller investor.
