Investment trusts - a strong case to make to investors

Investment trusts are hot with investors right now. How do we know that for sure? The internet tells us so.

In the digital world, retailers pay close attention to what consumers are searching for online in order to work out what they should be selling. When the investment analyst Morningstar recently conducted a similar exercise, by looking at what consumers using its website were searching for, they noted one particularly striking result: investment trusts are attracting ever more interest.

Given that Morningstar publishes a wide range of detailed information on every kind of collective investment fund, its results are significant. They suggest investors are embracing the investment trust sector with renewed enthusiasm.

A win for the watchdogs

Financial regulators don’t always get a good press, but they deserve some credit in the story of the rise of the investment trust industry in 2013. One of the most important explanations for this trend is that thanks to regulatory change, investors now stand a better chance of hearing the investment trust story.

In theory, the products that independent financial advisers recommend to their clients are the ones they think are best for the circumstances at hand. In practice, that hasn’t always been the case. For decades, managers of open-ended funds such as unit trusts were allowed to pay commissions to financial advisers who sold their products to clients. Investment trusts never had this option. Guess which type of fund dominated advisers’ lists of recommended investment products?

Then, last January, the financial regulators introduced a set of reforms known as the retail distribution review. One vital aspect of the reforms was a ban on commission payments of any kind; suddenly there was no longer any reason for advisers to favour open-ended funds over investment trusts.

The right story to tell

Investment trusts’ renaissance isn’t only down to the regulators, of course. It is one thing to suddenly have an opportunity to grab investors’ attention, but quite another to have a message that resonates.

However, the superior investment performance of investment trusts in most sectors of the market over most periods, short- and long-term, is a compelling proposition. One reason for that outperformance, by the way, is that the sector hasn’t been handicapped by the cost of paying commissions to advisers. Lower charges means better returns for investors, all other things being equal.

Offered the opportunity to invest in the same assets that you’ve been accessing through open-ended funds for many years, but with lower charges and the prospect of superior returns, why wouldn’t you say yes? Well, one explanation sometimes given for investment trusts’ relative lack of popularity is that their shares often trade at a discount to the value of their underlying assets.

That happens because of the closed-end structure of an investment trust. With a fixed number of shares in issue, the price of each share at a given moment is determined by demand and supply in the market, which can sometimes get out of kilter with the value of the fund’s assets.

This year, however, discounts have narrowed significantly – partly because so many more investors are buying investment trusts. There is an interesting debate about whether discounts (or premiums, which are also problem) are really such a worry, but either way, the issue has become steadily less important in 2013.

In good company

The biggest difference between investment trusts and open-ended funds is often the one that people miss. The latter are financial products, launched by fund managers in order to earn fees from their investors. Investment trusts, by contrast, are independent companies that must, under the very strict rules of companies law, be run with shareholders’ interests to the fore.

One important application of that principle (and there are many) is that investment trusts can – and often do – sack their fund managers when performance disappoints. Investors in open-ended funds do not have the same protection.

No wonder Morningstar’s analysis is showing so much interest in the closed-end sector. Investment trusts have a strong case to make to investors – and they’re finally getting a chance to make it.