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Chris Gilchrist: Investment trusts must clean up their act

Investment trusts do have a role to play the industry needs to address some pressing issues before demanding greater access to advisers and their clients.

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Managers of investment trusts continue to bang the sales drum. They insist the FCA’s independence rules require IFAs to consider ITs and include them in advised portfolios, justifying an ongoing ear-bashing for platforms that have not facilitated IT trading.

I think there are a few issues the investment trusts need to sort out before they muscle their way into platform space.

First is charges. Twenty years ago as a financial journalist I used to laud ITs for lower charges than unit trusts. Today the opposite is true: actively managed Oeics with clean share classes at 75bps cost half as much as many ITs.

So, like OEIC managers, IT managers need to cut their fees before they earn a place at the selection table. Only a handful have done so.

Second, it is time to can misleading performance comparisons. You cannot compare the price performance of an IT with an Oeic. It is a clear case of apples and bananas. The obvious distorter is variations in the discount/premium to NAV in an IT, which can cause returns to investors to vary significantly from the returns generated by the portfolio of investments. So the correct comparison is an IT’s NAV performance compared with an Oeic.

But even that can be misleading, because another distortion comes from gearing. Aggregate figures for ITs are sometimes quoted by people who don’t understand the data to show that ITs have performed better than Oeics. Well, if advisers told their clients to borrow £10-20 for every £100 they invested, as many ITs do, wouldn’t you expect them to get higher returns from a rising market? We need gearing-adjusted data to show whether IT fund managers really are adding value.

There are some ITs where stock selection has detracted from performance and it has been successful management of gearing that has generated good returns. I do not know about other advisers, but I would want to know how much gearing contributes to performance. Managers do not seem to have got the point that since it is the timing of changes in gearing that is critical, you need to use time-weighted rates of return to generate accurate figures.

Third, if the independent directors on IT boards were really as independent as the managers say, wouldn’t they have addressed the fee issue already? Looking at a typical IT board the phrase that comes to mind is ‘Round up the usual suspects’.

Fourth, the industry – it is after all the Association of Investment Companies – has allowed a set of new offshore investment companies to secure London listings. The big boys have only themselves to blame since they were among the guilty parties. High income commercial property trusts with 60 per cent gearing must have seemed a great idea to someone, but I cannot imagine any responsible adviser recommending these and other examples of madcap financial engineering to individual clients. There’s a bit more cleaning up needed in the sector.

I agree that there are many exceptionally good funds among investment trusts/companies, which merit consideration as ingredients in a portfolio. But there is also expensive dross in the sector, just as there is among Oeics. And for many advisers running model portfolios with regular rebalancing, the trading costs involved with ITs will make them a non-starter. So while ITs should have a bigger role, they will always be little in relation to the large of Oeics.

Chris Gilchrist is director of Fiveways Financial Planning, the author of the Taxbriefs adviser guide The Process of Financial Planning and edits The IRS Report

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  1. There’s a wide divergence in investment company charges, but many investment companies in the mainstream sectors have charges which are competitive with open ended funds and below 75bps.
    The fairest way of comparing performance is to look at the share price of investment companies as these are the returns an investor receives. Would advisers prefer that we ignore any discount fluctuations and the impact they have on investors’ returns? I doubt it but both NAV and share price figures are published, so advisers can look at both figures.
    On gearing, it’s a structural feature of investment companies and the average gearing level for the sector is 8%. Yes advisers should understand what impact it has on performance – the AIC have been busy training on this and that’s why many companies explain this more fully in their report and accounts.
    As for the independence of the board – well boards have been reducing their charges and this year ten investment companies have abolished their performance fee.
    The Association of Investment Companies is a trade association not a regulator. Our offshore members are well regulated and have to comply with company law, the listing rules and other regulations like our UK members. For many offshore companies the closed ended structure is providing access to illiquid asset classes like property and infrastructure which are proving popular, with the current strong demand for income. There are also plenty of big well-known investment companies in the retail sectors.
    Currently advisers’ clients make up less than 1% of investment company shareholders, whereas institutions, wealth managers and direct investors all have significant holdings in investment companies. So finally we can agree with Chris – investment companies should have a bigger role in advisers’ portfolios.

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