UK Individual Shareholders Society
WHY YOU SHOULD CONSIDER THOSE AND OTHER COLLECTIVE FUNDS
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This page is based on an article first published in a ShareSoc Informer newsletter.
Many private investors are happy to put money into funds, particularly if they are fairly new to stock market investing. What this often means is that they purchase OEICs, Unit Trusts or ETFs from their stockbroker or ISA administrator with a particular emphasis on the first two which are often strongly promoted to them by the “platform” they happen to use. And why is that the case? Simply because your broker makes a lot in commission as a result.
But there is an even better alternative which is an investment trust. These are investment companies which are listed on the stock market, some of which have been in existence since the 19th century. They typically offer the following advantages if you are looking for a “collective” investment vehicle:
1. Lower charges and better performance. They have lower charges, and hence tend to outperform their OEIC or unit trust equivalents. The reason for this is simply because they typically do not spend money on advertising or other promotional activities, which is why many investors are not aware of them. In addition, the company and its board of directors is usually independent of the fund management and administration activities so can negotiate and control the costs. For example Lipper reported in June 2012 that over 18 years the average investment trust returned £22,195 from an initial investment of £5,000 whereas the average OEIC returned only £15,705. Indeed this is even more evident when you examine the few cases where there are equivalent funds run by the same manager in both investment trust and OEIC/Unit Trust form. The latter consistently underperform the former even though the holdings in their respective funds are identical.
2. They can use gearing. They can enhance performance further by using gearing, i.e. borrowing money at lower interest rates than the return they obtain from stock market investment. Obviously gearing adds risk, but most investment trusts use it in great moderation.
3. The company and board are directly accountable to shareholders. The company and its board of directors are accountable to shareholders in the same way as in any other publicly listed company. You can vote directors off the board, go to the AGMs and ask questions, and generally engage more with the fund management (who of course attend the AGMs). In extremis you can encourage the company to fire the fund manager (or more normally the fund management company who are contracted to the company) and replace them – it does not happen often but it’s not unknown. Compare that with Unit Trust, OEICS or ETFs where you may get a report occasionally on the activities of the fund but that is all, and if matters are seriously going wrong, there is little investors can do about it. In investment trusts, the investors effectively own the company and have all the normal rights of shareholders.
4. You can acquire assets at a discount. Because investment trusts are “closed end”
funds, i.e. they generally have a fixed share capital, don’t issue new shares automatically
when there is more demand for the shares from investors, or have to buy-
Closed end investment funds are particularly suitable where the underlying assets
are not easily tradable by the fund manager. For example, with private equity or
direct property investments. Some “open-
Pooled investments versus doing it yourself. Now ShareSoc promotes direct investment in the shares of listed companies, rather than you relying on a fund manager to do it for you, which of course incurs charges. Also the chances are you may find the chosen fund manager only of average competence (the global pool of investment managers can only ever achieve the global average of investment management performance!). So why choose a pooled investment? The reasons may be several:
A – You may not have the competence or ability to easily invest in a chosen sector. For example, if you wanted to diversify your portfolio with some investments outside of the UK by buying shares in Chinese companies or in other Emerging Markets, doing it yourself could be very difficult. Likewise investing directly in private equity (i.e. in unlisted companies) will be practically impossible. You may know a lot about certain sectors but be more wary of others that are more specialised, such as technology or property.
B – You may simply reckon that paying an investment trust company 1.0% per annum
(charges vary and can be higher or lower than that) so as to avoid having to deal
with contract notes, monitor your investments and generally worry about your holdings
is a good deal. Depending on how you value your own time, this could be a good trade-
C – There are capital gains tax advantages in that any trading done by the investment
trust is not subject to capital gains tax on the investment trust company whereas
if you held the same underlying shares directly you might well pay that. Even if
you don’t trade often, there are always the occasional take-
Summary. So in summary, investment trusts can be a useful element of any portfolio and should always be considered as an alternative to unit trusts, OEICs or ETFs. Incidentally ETFs can be very low cost but suffer from the same opaque information and corporate governance issues and are positively dangerous when they are “synthetic” ones based solely on the use of derivatives rather than the fund holding the underlying assets because they introduce “counterparty” risk.
But there are a very wide range of investment trusts, from generalist funds to specialised sector or geographic funds. That’s ignoring the even more esoteric areas of Split Capital Investment trusts and Venture Capital Trusts which the author may cover at another time.
The Association of Investment Companies (AIC) web site (www.theaic.co.uk), which
is a representative body for investment trust companies, contains data on such companies,
including past performance information. But as always, you are reminded that past
performance is not necessarily a guide to future performance. The AIC web site now
shows the overall charges in the form of “On-
As some investment trusts pay performance fees to their fund managers, the AIC also
reports a separate “On-
As with any fund, one needs to be wary of new trusts or those with a short track record, those that are small in size or more specialised and hence may be more risky/volatile, and those that are fashionable or in hot sectors (where discounts to NAV will often be low). Be wary of following celebrity fund managers with apparently great track records. Their performance can slump, or they sometimes retire or simply move on. The “investment policy”, which tends to dictate the investment style of an investment trust, is often more important than the individual lead fund manager. Do not be fooled that you have the ability to pick out a good individual manager because there is little scientific evidence that it is possible, and most of them tell a good tale (they are usually expert at explaining away their recent poor performance, or claiming credit for their recent superior stock picking).
Another useful web site is FE Trustnet as that includes most investment trusts and other fund types so you can compare their relative performance.
With the Retail Distribution Review requiring full disclosure of charges and IFAs
definitely being required to offer “best advice” rather than recommending products
on which they get the most commission, it is likely that investment trusts will become
much more popular in future. But regardless, they are surely something that all investors
should be more aware of, and certainly consider them in preference to open-
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