Looking for recovery

It’s always darkest before the dawn. Investment trust directors and managers will hope that maxim proves true in their case after a horrible year. New data from the AIC shows purchases of investment trust shares on investment platforms used by financial advisers were down 28% in 2023 – and fell below sales of shares for the first time in more than a decade, leading to negative net demand. Elsewhere, research published by Winterflood put demand for investment trust shares at its lowest level since the industry analyst began surveying its clients 12 years ago.

That latter research prompted one newspaper to ask, “could this be the beginning of the end for the sector?” That feels over-dramatic, but there’s no denying many trusts have had a very tough period. Managers have found it hard to deliver returns in markets with real headwinds – soaring inflation, high interest rates and geopolitical volatility. The discount problem has compounded the misery, with investment trust shares slipping to an average discount to the value of their underlying assets of around 11%.

Other challenges have included a row over regulation, with many investment trusts aggrieved that rules on charging disclosures put them at an unfair advantage. Plus, there has been concern about the viability of smaller investment trusts, which offer exposure to specialist investment propositions but may struggle with illiquidity – that is, the market for their shares can be more limited.

All of which adds up to a perfect storm, leaving investment trusts feeling more battered than at any time in recent memory. The question now, of course, is where investment trusts go from here. Is there worse to come or could investors tempted to return to the sector have an opportunity to get in right at the bottom?

Well, calling peaks and troughs of markets is never a good idea. It makes more sense to focus on the basics. And the fundamentals here are that investment trusts remain well positioned to deliver attractive long-term returns for shareholders. Looking backwards, after all, investment trusts have tended to outperform other types of funds making similar investments over extended periods.

There are lots of reasons for that. Investment trusts can take on gearing, which helps in rising markets. They’re competitive on charges. They have more flexibility to retain income to support dividends. The governance structure is helpful too – investment trusts are unique in having boards of directors with a fiduciary responsibility to work in the best interests of shareholders.

In certain asset classes, moreover, investment trusts come into their own. The structure with which some investors feel uncomfortable provides real protection when the fund is investing in areas where liquidity is lacking – real estate and infrastructure, for example. Shares in the investment trust can be freely traded even when the underlying asset is much harder to buy and sell quickly.

It's also encouraging that investment trust boards are taking action to confront their challenges. They’re running comprehensive share buyback programmes to try to bring discounts down. They’re changing fund managers to boost performance. They’re cutting charges. Some are even pursuing more radical options – merging with other funds to secure scale, for example.

None of which is to say that now is the moment to plunge into investment trusts. But the underlying proposition remains sound – and if you can buy a portfolio of assets at 11% below their reported value, that’s worth at least considering.