The IFAs' best-kept secret

Not only do investment trusts charge lower fees unit trusts, they have also significantly outperformed the latter in recent years. So why don't IFAs recommend them more often?

As regular readers will know, we like investment trusts.

Not only do these stock-exchange-listed funds charge lower fees than unit trusts, but because their shares often trade at a discount to the value of their underlying portfolio, you can frequently get £1 of assets for 90p or so if you buy at the right time.

But it seems they're not just better value than unit trusts over the past five years they have also significantly outperformed them, according to a new study by Investment Trusts magazine. One thousand pounds invested in the average investment trust five years ago would now be worth £2,383, against £1,812 for a typical unit trust.

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The difference remains even when you compare apples with apples, says John Greenwood in The Daily Telegraph. Harry Nimo's UK Smaller Companies unit trust returned 195% over the past five years, but his Standard Life UK Smaller Companies investment trust has shown a 262% return. This is partly due to the fact that he can borrow money, or gear up' in order to enhance returns. This, of course, can have the opposite effect if he happens to make a wrong call, but he hasn't yet.

The other reason for outperformance is those lower fees investment trusts typically charge an annual management fee of about 0.5%, and nothing upfront (though you will pay stamp duty and dealing charges to buy the shares). Unit trusts, on the other hand, charge a typical 1%-2% a year, and as much as 5% upfront if you buy directly from the fund manager (although you can trim this charge by buying through a fund supermarket).

So why don't independent financial advisers (IFAs) recommend them to their clients more often? Simple: it's all about money. Peter Nellist, a partner at Clarke Willmott, tells The Times that, "unit trusts and OEICs pay advisers an upfront commission of 3%, plus 0.5% a year, whereas investment trusts pay none". Commission-based IFAs, therefore, have less of an incentive to suggest investment trusts to their clients, as they won't make any money by doing so. It just shows once again that if you want truly independent financial advice, you need to go to a fee-only IFA.

Or you could investigate the sector yourself. Some European investment trusts trade on attractive discounts right now. They are even more interesting if you believe as currency markets do that sterling will fall against the euro next year, as that would raise the value of euro-denominated assets in sterling terms.

"All the news we've seen recently about sterling and the UK economy has definitely been in the bearish camp," says Bank of New York Mellon's Neil Mellor on Reuters. Two worth a look are Henderson Euro Trust (HNE), on a 9.6% discount and F&C Eurotrust (FCU), which trades on an 8.5% discount.