Why more investors are buying investment trusts?
Industry figures show a surge in demand for investment trusts. We explain which types of trust are most popular – and why.
20 Oct 2017
Unstructured Learning Time
Demand for investment trusts has surged higher, industry figures show.
Investment trust sales on adviser platforms - a popular way for advisers and wealth managers to buy funds for clients - hit £514m in the first six months of this year.
This was 74% higher than a year earlier, according to data from the Association of Investment Companies (AIC)1.
John Spedding, Head of Investment Trusts at Schroders, said: “The continuing demand this year reflects the ongoing search for income as well as buoyant markets.
“But it also reveals a growing appreciation of the structural advantages of investment trusts, which could contribute to superior returns over the long term.”
The global funds sector garnered the most sales in the first half of this year, accounting for 15% of adviser purchases. Sales were also particularly strong in a number of other sectors where investment trusts offer some advantages compared with more commonly held open-ended funds or unit trusts.
Positive on property
Last year, the June vote to leave the EU temporarily knocked confidence in the UK real estate market and sales of property funds. However, the negative sentiment did not last, and by the end of 2016 the UK property fund sector has returned to a semblance of normality.
With confidence restored, sales of property investment trusts increased significantly in the first half of this year. “Property Direct – UK” was the second highest selling investment trust sector between January and June, accounting for 13% of total purchases. It follows a total return of 102.5% for the average trust over five years, or 15.2% as an annual rate, according to AIC data on 8 October.
The structure of investment trusts makes them potentially well-suited to investing directly in property. Physical commercial property, such as retail, office and industrial premises, can be illiquid, meaning they can be difficult to buy and sell in a hurry.
This can create difficulties for open-ended funds when many investors try to sell at the same time. This was important in 2016, when withdrawals were restricted on open-ended property funds, due to Brexit-related selling.
There were, by contrast, no withdrawal restrictions on property investment trusts. As closed-ended funds, investment trusts have a fixed number of shares in issue. When an investor wants to sell an investment trust they have to do so via the stockmarket. This means they are less vulnerable than open-ended funds to the risk of having to sell assets at short notice due to high levels of redemptions.
However, selling an investment trust when many others are trying to do the same can mean selling at a price lower than normal. The trust sells at a greater “discount”, in the industry parlance.
Ian Sayers, Chief Executive at the AIC, said: “It’s clear that advisers are not only recognising the benefits of investment companies for equities but are increasingly aware of the strength of the closed-ended structure for accessing illiquid assets.”
The income advantage
Investment trusts also have their attractions for investors needing a reliable income. “UK Equity Income” was the third best-selling investment trust sector in the first six months of 2017, netting 11% of total sales2.
This follows strong performance, with an average total return of nearly 75% over five years, to 8 October, according to the AIC data. It is equivalent to an annual average return of 11.8%3.
The average yield, or annual dividend income, for the UK Equity Income sector is 3.6%, even after the recent strong performance.
Investment trusts have a unique ability to hold back up to 15% of income generated by the dividends they collect during bumper years to keep reserves for any tough times that lie ahead. This can help them deliver a steady income whatever the market conditions.
Sue Noffke, Fund Manager, UK Equities, said: “Investors have to be very selective when picking stocks for income. Just because a stock has a high yield today, it doesn’t mean it will do tomorrow. An increasing number of companies have found it a stretch to continue paying dividends at the rate they have been.
“We only hold stocks with high yields when we’ve done our homework, when we know the company can afford to keep paying dividends.
“We also search for stocks that have plenty of scope to grow dividends. These may be businesses that do not need to reinvest vast amounts in the business and can give a little more to shareholders in the future.
“We also see opportunities for income investors within niche areas of property, such as companies managing student accommodation, which is an area of fast-growing demand. One of the companies in this sector paid a yield of 2.7% last year and has grown its dividend by more than 50% over the past three years since we bought the stock.”
The yields were taken from Bloomberg on 10 October.
Focused on long term success
The special structure of investment trusts can allow their managers to focus on the long term without worrying too much about short-term noise. This can be reflected in superior performance.
According to statistics from the AIC, investment trusts in most sectors have beaten open-ended funds over the medium and long-term4. Of course it’s important to recognise that past performance is no guide to future performance and your capital and income is at risk.
One reason for the strong performance of investment trusts in rising markets is “gearing”. This is the ability, within limits, to borrow money to use for further investments. Only investment trusts are allowed to borrow money in order to invest in this way.
In a rising market, returns and income streams from an investment trust can be magnified because gearing means managers are better able to take advantage of rising share prices. However, when share prices fall, the losses of geared funds can be exaggerated.
Investment trusts are not for everybody. Because trusts are traded on the stock exchange they may be bought and sold at any time. However, an investment trust can trade at a price that is lower (a ‘discount’) or higher (a ‘premium’) than the underlying value of its portfolio - the net asset value (NAV). This is an added complication.
However, investment trusts offer peace of mind that should you want to access your money you know it is readily available.
Please remember that past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.
Investing in specific sectors or regions can carry more risk.
1AIC: Investment company purchases at record level in first half of 2017, 25 September 2017.
2The AIC as at September 2017
3Schroders, as at October 2017. Annualised return calculated using online financial calculator – http://everydaycalculation.com/annualized-return.php
4AIC: Investment Companies v OEICs/unit trusts to 30 June 2017
The views and opinions contained herein are those of Sue Noffke, Fund Manager, and the named individuals. They do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds and are subject to change
This article is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Schroders has expressed its own views and opinions in this document and these may change. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.
Issued in October 2017 by Schroder Unit Trusts Limited, 31 Gresham Street, London, EC2V 7QA. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority. UK12322