On Monday I wrote an article eulogising investment trusts and predicting more great things for the sector.
And wouldn’t you know it. The very next day, one of the biggest, best known investment trusts saw its share price slashed as news of the departure of its star fund manager, Neil Woodford hit the screens.
Now, I warned that the most popular trusts have been bid to a premium. In fact, the number of star trusts now trading at premiums is something that I’ve never seen in my 20 odd years of investing in the sector.
This episode highlights some very important differences between investment trusts and their more commonly traded peers such as unit trusts.
There are three lessons to take on board here. Anyone interested in investment trusts should take heed.
It’s all about value
All too often investors make the mistake of thinking investments trusts are a proxy for more common funds like unit trusts. They get the point that the fees on these funds are keener, and they just throw their money into the most popular trusts.
But it’s important to take into account the significance of how an investment trust works. It is a company in and of itself. It trades on the stock market and is subject to the same forces of supply and demand as any other stock. This is fundamentally different to unit trusts, OEICs and ETFs where prices are derived from the value of the assets in the portfolio.
Investor appetite for a popular investment trust drives the value of its stock to a premium over the value of the assets (known as net asset value, or NAV). I was taken aback by last week’s research document from Morningstar, revealing how, of the ten most popular investment trusts, nine were now trading at a premium to assets.
Third on Morningstar’s ‘top of the chart’ investment trust’s is The Edinburgh Investment Trust. For ages now, the fund has been trading at around 2% higher than the value of its assets.
But as news broke that its star fund manager was to part company from Invesco (Edinburgh’s fund manager) the stock fell by a dramatic 10%. Many investors will have been shocked and stumped at how this could happen. It certainly didn’t happen to the unit trusts also managed by Woodford.
The first big lesson then, is to be very aware of how much you’re paying for an investment trust. Is it trading at a discount, or a premium to its asset value? Get the trust’s factsheet (nearly always available free on the trust’s own website); all the key information will be on it. Most of the trusts that I tend to deal with trade at a discount of around 10% to 12%.
In fact, with the Edinburgh trust now trading at an around 8% discount to assets, it’s probably the best value it’s been in long while.
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So why the big drop?
While stock prices are undoubtedly driven by supply and demand, there’s a subtle nuance that you should be aware of. What I mean is, it would be more accurate to say that prices are driven by anticipated supply and demand. And there’s a big difference.
As news of Woodford’s departure hit the market, traders slashed the bid (the price at which they’re willing to buy stock). The price moved in anticipation of what these guys think investors will do. Knowing that a load of investors would undoubtedly want to bail out of the Edinburgh trust, traders moved the bid. Now all they are offering is a lousy price for anyone that wants to follow Woodford out.
In the same way that many investors piled into this popular fund without taking into account the valuation premium, many will now pile out at precisely the time when the valuation is at its worst.
Well – if investors don’t understand what they’re getting into, more fool them. But it does still leave the question of how the Edinburgh trust will now cope without its captain…
There are plenty of bright fund managers around
As I described on Monday, the main reason I’m such a diehard supporter of investment trusts is their long term investment horizon. Remember, this is a company, it has a life of its own – it is a lot more than any one individual. The Edinburgh investment trust was established for the purpose of a pooled investment fund back in 1889. It’s seen many ups and downs and changes in management over its history.
Before Invesco’s Woodford won the mandate to manage its investments, the fund was managed by fund management group Fidelity.
This trust can find another star fund manager at the drop of a hat. And anyway, Woodford isn’t leaving until April next year, and even when he does leave, the investments will still bear the hallmarks of his long term value approach. The fund is an ocean liner – it’s on a course; it’s not as if the thing has been hulled!
The board of directors will wait patiently as they search for the new fund manager. There’s a big pool of talent out there – they’ll bide their time and find the right manager, either within, or outside of the Invesco group. The long term approach will shine through.
However, Invesco’s unit trusts face a more difficult challenge. Because of the way they’re set up, they will have to appoint a fund manager to take over as Woodford stands down. There’s undoubtedly pressure to appoint a manager, and to do so quickly. Independent financial advisers hate the unknown – they will want to see a transition plan immediately, otherwise they’ll start to withdraw client funds. Who’s to say that Invesco can find the right candidate, and find him or her fast?
As always, I’d rather have my money in the fund offering a patient, long term approach.
This is what investment and investment trusts are all about. The key lesson is, be darned sure you know what you’re getting into. Buy when the valuation is cheap, and sell when it’s expensive. But then again, you already knew that didn’t you?
• This article is taken from the free investment email The Right side. Sign up to The Right Side here.
Information in The Right Side is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. The Right Side is an unregulated product published by Fleet Street Publications Ltd. Fleet Street Publications Ltd is authorised and regulated by the Financial Conduct Authority. FCA No 115234. http://www.fsa.gov.uk/register/home.do
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