Simon Elliott: Investment trusts down but not out

Former Winterflood analyst and now JP Morgan director challenges the idea that the bubble for investment trusts has burst following last year's derating of the sector's share prices.

Investment trusts stumbled last year. After more than a decade of strong performance, buoyant fundraising conditions and narrowing discounts, the sector was hit by a combination of falling markets and rising interest rates.

The sector average discount – the disconnect between the share price and the value of the trust’s assets – widened from 1% at the start of last year to 13% by the end, with the average discount briefly touching 17% at one point, according to Refinitiv. And for the first time since the 1970s, there were no flotations or IPOs, with a series of unsuccessful or postponed launches.

So, has the bubble burst for investment trusts? In short, no. With over 150 years of history, investment trusts have seen it all. Their ability to withstand war and pestilence demonstrates the inherent advantages of the closed-ended structure and its ability to offer investors key advantages such as greater dividend certainty and exposure to less liquid assets. Assets like infrastructure projects, for example, which are typically more difficult to access.

The closed-ended nature of investment trusts not only provides a significant advantage for active fund managers by better allowing them to access less liquid asset classes or securities, it also enables managers to take long-term investment decisions without having to worry about short-term investor flows.

This is one of the key factors in explaining why time and time again investment trusts tend to outperform their open-ended equivalents over the long-term.

Another important part of the story is dividends. While not every investment trust pays a dividend, many do, drawing on their revenue reserves to maintain or even boost payouts in tough times.

The pandemic is a recent example. When many companies felt compelled to suspend or cut their dividends because of falling revenues and huge uncertainty, the vast majority of investment trusts maintained, and in many cases, increased their dividends, dipping into their reserves to cover any shortfall.

There are now 17 investment trusts that are so-called ‘Dividend Heroes’, according to the Association of Investment Companies. These represent trusts that have grown their dividends every year for at least 20 years. The list is led by City of London (CTY ), with an impressive unbroken 56-year record. Seven other investment trusts make up the 50 or over camp, with the latest entrant being JPMorgan Claverhouse (JCH ).

Another development across the sector in recent years has been the adoption of enhanced dividend policies. Subject to shareholder approval, investment trusts can now distribute capital, rather than just revenue. This means that investment trust managers don’t have to invest in just those dividend-paying companies to pay dividends to shareholders.  

Some have described this strategy as being able to have your cake and eat it and in theory that’s true: an investment trust’s portfolio can be positioned for growth and yet still offer attractive levels of income.

Critics may argue that it is tax inefficient given the different tax rates payable on income and capital gains for UK-based taxpayers. However, supporters of the model say it’s justified given it creates more demand for their shares and, in time, leads to narrower discount levels or even premium ratings.

Investment trusts have been written off before. But as history continues to suggest, the sector is more than capable of getting back off the canvass and delivering for its shareholders, especially those with long-term investment horizons.

Certainly, there are many who see the current level of discounts across the sector as an attractive value opportunity, particularly those who are prepared to take a contrarian view and buy into out-of-favour asset classes. Bargains always stand out, even more so in a cost-of-living of crisis, and the prospect of buying assets at a discount to their value has to be worth another look. Investment trusts are down but not out.

Simon Elliott is a client director at JP Morgan Investment Trusts and the former head of investment companies research at Winterflood Securities.

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