Look through the noise and see the benefits of investment trusts

Where does the truth lie? Well, it’s fair to say that investment trusts have faced some significant challenges over recent years. For a whole bunch of reasons, many of them out of trusts’ control, it has been tricky to deliver the returns that investors expect. 

During a period of rising interest rates, geopolitical volatility and increased risk aversion, equity markets have often stuttered; the fact that shares in investment trusts can trade at discounts to the underlying value of their assets has compounded performance disappointments.

More recently, however, broad investment sentiment has improved – indeed, the past 12 months have seen multiple stock markets hit all-time highs. Many investment trusts have benefitted. Plus, investors have enjoyed a double boon as discounts have narrowed.

However, all of that is really just a description of the natural market cycle. Rollercoaster rides on global stock markets – and in other asset classes – are nothing new. Investment trusts have always been exposed to these ups and downs.

The broader question, then, is whether something unique has been taking place in the investment trust sector. Are investment trusts dealing with issues that other collective investment funds don’t have to worry about?

The answer to that is interesting. Yes, investment trusts have faced pressures that don’t apply to unit trusts or other so-called open-ended funds. But those pressures stem from the distinctive structure and operating model of investment trusts, which also bring real benefits. In that sense, investment trusts’ greatest weaknesses can also be their biggest strengths.

Remember, investment trusts are stock market-listed companies that appoint an investment manager to buy and sell assets on their shareholders’ behalf. That’s a very different proposition to an open-ended fund, which usually creates units based on the value of the assets it holds.

The stock market listing brings challenges. Most obviously, the price of an investment trust’s shares can move significantly out of kilter with the value of its underlying assets – to a discount or a premium. Also, anyone can buy an investment trust’s shares, including activist investors who may arrive with a different agenda. There may also be question marks around size and liquidity.

Equally, however, the structure of an investment trust has some critical advantages. All trusts are run by boards of independent directors, who have strict legal responsibilities to safeguard the interests of shareholders. Boards can – and do – take radical action in this regard, from sacking fund managers to closing down the fund to return money to shareholders.

In addition, with a fixed pool of assets to run, investment managers can take long-term decisions. Investment trusts can invest in illiquid asset classes with the potential to generate outsized returns. And they can take direct action to manage discounts, including buying back their own shares where necessary. This reduces supply and helps support the price.

Add in a couple of other attributes unique to investment trusts – their ability to take on gearing and to structure income payments with greater flexibility, for example – and you can see why the long-term track record of the sector is impressive. In most asset classes and stock markets, investment trusts have, in the past at least, consistently outperformed other types of fund over the long term.

All of which is to say that the noise around investment trusts in recent times is understandable but distracting. The difficulties some funds have experienced have typically been a consequence of the very nature of investment trusts. But in many cases, investment trust boards have taken action in response. That leaves investors well placed to benefit as the sector’s advantages reassert themselves.