Putting our trust in investment trusts

We recently launched the Wealth Club Portfolio Service, an online discretionary fund management service designed specifically for high-net-worth investors.

Perhaps surprisingly for a new online service, the portfolios make use of an investment structure first used in 1868 – the investment trust. They play a key role in achieving the level of diversification needed for a wealthier investor’s portfolio. 

In particular, investment trusts provide access to asset classes and investment strategies that we can’t access using index funds or actively managed funds alone. As a result, we invest 10-20% of each portfolio in investment trusts. 

How are we using investment trusts

We use investment trusts in two ways. First, we use them to invest in private assets that cannot be accessed via public markets. 

Investment trusts allow us to invest in assets such as private equity, infrastructure, and real estate. We would struggle to invest in these types of assets if we were restricted to daily traded index funds and actively managed funds. Investment trusts bring something different to our portfolios. 

Our infrastructure trusts for example have an enviable track record of delivering a reliable income stream with dividend growth over time. They have also been excellent diversifiers during the cost-of-living crisis.

The second way we use investment trusts is to access investment strategies that focus on less liquid areas of public markets.

Some investment strategies are just better suited to being managed within an investment trust structure. 

We know that the typical fund investor buys after a period of strong performance and sells after a period of weak performance. 

Managing fund inflows and outflows can be a real challenge for fund managers that invest in less liquid assets. It can exacerbate periods of poor performance, as open-ended funds can be forced to sell during a period of volatility to fund investor redemptions. 
 

The closed-ended structure of investment trusts mean managers need not worry about inflows and outflows into the fund. The permanent capital structure is therefore particularly well suited to contrarian investment strategies that seek out unloved and illiquid parts of equity markets. 

Compare Fidelity Special Values, a holding within our higher risk portfolios, to its stablemate Fidelity Special Situations. Both pursue the same investment strategy, both have the same portfolio manager, both have access to the same (significant) resource behind the scenes, both have very similar underlying portfolios. However, over the 20 years to 31 December 2023, Fidelity Special Values has outperformed its open-ended equivalent by an average 4.1% per annum, a cumulative 123.2%.

What are the risks?

There are two key risks to be mindful of: liquidity and discount volatility. To manage these, we have strict limits on our total exposure to investment trusts within each portfolio. We find during periods of market distress, discounts across investment trusts can widen in unison. Today’s wide discounts may be an opportunity, but it’s important to have limits in place. 

For liquidity, we look at average traded volumes over a three-month period relative to the position size in a portfolio. We err on the side of caution here, favouring larger and more liquid investment trusts with market caps greater than £750 million. As a newly launched service, clearly we do not have significant issues with liquidity, but must be prepared as the service grows. The lack of fixed dealing fees is an important feature of the service, meaning we could, if required, exit a position gradually over time without generating excessive trading fees. 

A competitive advantage

With sensible risk management policies in place, we believe the inclusion of investment trusts is an important competitive advantage for the Wealth Club Portfolio Service. 

They mean we can own a greater array of assets and investment strategies. We believe this adds resilience to our portfolios and can boost our clients’ longer-term returns for a given level of risk.