‘Investment trusts can provide long-term advantages’

May 3, 2024

4 minutes read

Investment trusts have been around since the 1860s and right now, an awful lot of them look like long-term bargains.

Investment trusts are public limited companies (PLCs) that are listed on the London Stock Exchange. Their sole business is to invest on behalf of their shareholders.

Typically, we hold investment trusts within our bespoke portfolio service, which gives you access to a broad universe of investment assets.

Investment trusts are sometimes overlooked, but they can have some important advantages over the long term.

Generally cheaper

Investment trusts have long been committed to low costs and tend to have lower total expense ratios than open-ended funds such as unit trusts.

Access hard to reach assets

We particularly like investment trusts as their unique structure allows us to access a wider range of assets such as renewable infrastructure and private companies.

An investment trust has a fixed number of shares to buy (a closed-end fund), and fund managers do not have to buy and sell shares to meet demand. This gives the fund manager more control as they can buy and sell when they believe the time is right.

Borrowing power

By borrowing money (a process known as ‘gearing’), investment trusts can potentially boost returns, though it can also magnify losses as interest rates rise.

Trust structure

The value of your investment is based on the share price of the investment trust, not necessarily the value of the underlying assets.

Depending on these factors, an investment trust’s share price could trade above the underlying value of the portfolio (at a premium), or below the underlying value of the portfolio (at a discount).

Unfortunately, some of the advantages of the investment trust structure can work in reverse.

A year to forget

Last year was a tough one for investment trusts. The average trust shouldered a double-digit discount – the first time this has happened since the global financial crisis.

Of the 392 trusts listed on the Association of Investment Companies website, around 220 lost money. In around a quarter of those cases, however, the trust’s share price has fallen despite its manager achieving growth in the value of its underlying investments.

The pressure that has caused a significant de-rating in the sector should begin to abate.

Investment trusts are also grappling with some structural issues. A consolidating wealth management industry increasingly favours bigger, more liquid trusts, at the expense of the smaller players in the sector.

Discounts persist – but so do opportunities

Rising interest rates in the sector has led investors to ask for higher returns and dividends than have been incorporated in the asset values of the funds, which has contributed to the emergence of sector share price discounts. However, we view this as a substantial long-term opportunity.

Despite the negative sentiment and difficult backdrop, earnings and revenue growth are generally remaining resilient in underlying portfolios.

Trusts on the path to net zero

Climate change is showing signs of accelerating and demand for portfolios of existing cash-generating renewable and infrastructure assets is likely to remain robust.

At the same time, interest rates are at levels that we believe are at or near the peak, so the pressure that has caused a significant de-rating in the sector should begin to abate.

We believe there is a significant opportunity across the trusts we hold. One such example is Greencoat UK Wind.

Due to its strong cash flow, the trust, which is one of the UK’s largest wind farm operators, has remained resilient:

Plans to pay a 10p dividend in 2024 on a share price of 138p. This dividend has a coverage ratio of 2.1 times.
Cash flow is inflation linked to energy prices.
Excellent if you are targeting income or growth, with returns significantly above cash or bonds.

The renewable and infrastructure sector remains highly attractive. From trading at a premium to NAV, the sector now trades at a substantial discount, meaning investors will benefit from both increases in the value of the investment and these discounts closing. Patience is the key.

Managing discounts

A unique feature of investment trusts is that they come with their own independent board of directors, and can take action to reduce if it gets too wide.

At the end of March, the board of the £14bn Scottish Mortgage Investment Trust announced a £1bn buyback (the largest ever for an investment trust) to prop up its share price, which is currently at a 13 per cent discount to its NAV.

As with any investment, the benefits need to be considered in the context of the risks.

In a signal that international investors are taking advantage of the value on offer, Elliot Associates has acquired a 5 per cent stake. Elliott Associates is known for being one of the largest and most successful activist investors in the world, with a track record of driving significant improvements in the companies it invests in.

Regulatory uncertainty

Another driver of wider discounts has been a change in the guidance about cost disclosures around holdings in investment trusts. The sector has been undermined in recent years by charges disclosure rules being misapplied to investment trusts, forcing these companies to exaggerate the costs of holding their shared.

The good news is that the government has asked the Financial Conduct Authority to resolve these issues. A reform of the requirements to disclose costs could increase demand for investment trusts, potentially helping to narrow discounts in the sector.

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May 3, 2024

4 minutes read