I’m a huge fan of investment trusts – I invest in them and I sit on the board of three of them. They have a long-term history of outperforming. In 2018, Cass Business School produced a study that took into account every issue they could think of that might distort the comparison between investment trusts and open-ended funds and still found that the trusts had outperformed by about 1.4% a year over the previous 18 years. Compound that over a couple of decades and you are talking real money.
They work brilliantly for anyone wanting to hold illiquid assets – this is the way to invest in micro caps, infrastructure, property and renewables. They can use borrowed money to pimp up returns – and history suggests they more often than not add value in doing so.
Possibly best of all, they have active boards of directors charged with representing the long-term interests of shareholders. This appears to make a genuine difference: even after Cass had adjusted for sectoral bias, gearing and share buybacks, the outperformance of trusts was still about 0.8% a year, which suggested to them some kind of magic in the structure of investment trusts.
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Investment trusts aren’t perfect
So what’s not to like? A few things. The first is cost. Until relatively recently, trusts were generally cheaper than open-ended funds (and we all know that current costs are one of the main drivers of future returns). No more. Management fees have fallen for both types of investment but costs have risen for investment trusts. Regulation never stops increasing for listed companies, and each new clause and sub clause pushes up the cost of compliance.
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As trusts lose their cost advantage, will they also lose much of their performance advantage? The jury is still out on this, though one obvious way to mitigate the cost risk is for smaller trusts to merge and make some economies of scale. They mostly don’t – as in all mergers, it would mean directors losing their jobs and they aren’t mad for that – but perhaps they should.
There’s also tax risk. One of the cornerstones of the trust model is the rule that as long as a trust pays out 85% of the dividend income it receives to its shareholders, it does not have to pay capital gains on share sales made within the trust. This is to prevent shareholders effectively paying CGT twice – once on the sale inside the trust and again when they sell the shares in the trust.
But Rishi Sunak appears to be having some unsound thoughts on CGT as a whole. If the chancellor is unfriendly enough to suggest it is reasonable for investors to pay their marginal rate of income tax on their capital gains (as the Office of Tax Simplification suggested this week) without rushing also to propose the abolition of the UK’s other wealth taxes (imagine paying CGT of 45% followed by inheritance tax of 40%) what else might he think of?
CGT is going to be “reformed” one way or another, since this fits neatly with the “make the rich pay” political narrative of the moment. The industry needs to be alert to the risk that it could get caught up in that reform. There are other worries you could add to the list. But the thing trusts need to think most about is their relationships with their small investors.
Investment trusts are wooing retail investors
The past few years have seen a push by the sector to attract retail investors into trusts. I approve of this for all the reasons mentioned above. But if you end up with a shareholder base of lots of small private investors, many of whom will be less experienced than the institutional investors that used to be the mainstay of many shareholder registers, you have to look after them. That means very good communication around matters of discounts and premiums – investors need to know the risks of buying investment trust shares when they are trading at a premium to their net asset value in particular. It means responding to rising investor demand for more transparency, on ESG issues in particular.
Crucially, it means encouraging interaction. One of the great joys of the investment trust is the annual general meeting. Open-ended funds do not provide an annual opportunity for small unit holders to turn up and directly quiz the directors and fund managers over a cup of coffee (or an actual lunch at the likes of Personal Assets and Alliance Trust, both of which I hold). Trusts provide just that for their shareholders.
This is brilliant for the manager and directors. If I were asked what it is about the structure of investment trusts that makes a difference to performance, I might just single out these meetings. For the manager to see individual investors and hear their questions face to face is a nice reminder of the point of the whole thing. It is not to bask in the glory of outperformance and prizes. It is to finance the lifestyles (and often the retirement) of people who are not necessarily as well off as the average fund manager or trust director.
One of many miserable side effects of the pandemic has been the cancellation of these events, just at a time when investors need more rather than less engagement. Already voting levels across all companies are low – only around 6% of retail investors vote with their shares. That’s partly logistics (not all platforms make it easy), partly because they aren’t interested, and partly because they don’t get enough direct contact from the companies in which they invest to be interested.
Trusts can’t do much about the second of these but they can press the platforms on the first and do more on the third themselves. The more they do those things, the brighter the sector’s future will be – as long as they keep giving us our extra 0.8% a year as well, of course.
• This article was first published in the Financial Times
