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Ringing the changes

Investors with nous are latching on to the new-style investment trusts

With the year entering the home straight, the invest- ment trust sector is on course for its biggest outflow of money in the industry’s 138-year history.

Nearly £3.4bn has been lost so far this year, with £2.6bn having been returned to investors through buybacks, tenders and redemptions and a further £770m lost through liquidations, which have included several split-capital investment trusts. This year is set to be the seventh year out of the past eighth where net cashflow has been negative.

On the face of it, the numbers look grim for an industry that has been struggling against the odds since the millennium. But perhaps the figures mask the real story of an evolving industry.

The huge outflows are down to the old guard of the investment trust world. Many of these venerable mainstream equity investment trusts have been struggling to attract money from private investors.

But what the outflows fail to illustrate is the changing nature of the investment trust industry. The closed-ended nature of investment trusts are well suited to asset classes that are illiquid because they are not forced sellers. As such, it is busy carving niches in specialist areas such as property, private equity and emerging markets.

Indeed, last year was a bumper year when more than £3bn was raised via new trusts, many of which are domiciled offshore, reward managers with performance fees and use hedging techniques and derivatives.

Private equity, which has been the buzz phrase in the City, has buoyed the sector (private equity investment trusts are the number-one performers over the past decade) while investor interest in commercial property has provided a huge fillip.

Sophisticated investors are latching onto the new-style trusts but perhaps all investors are missing a trick when it comes to the traditional trusts.

Unit trusts grab the headlines and the ad space but it is investment trusts that have delivered superior performance over the past three and five years. Investment bank Dresdner Kleinwort’s latest annual review of the industry says investment trusts have outperformed 12 out of 15 comparable sectors over three and five years.

For example, over the past three years, the average net asset return for a global investment trust is 67 per cent over three years compared with 49 per cent for the average global unit trust. Over five years, the figures are 22 per cent and 3 per cent respectively.

Dresdner admits that the unit trust data used is after the deduction of charges and that an adjustment should be made but says the outperformance is so significant in many areas that this would make little difference to the outcome.

It also admits that gearing has played a part, as it does when markets rise, and that trusts that borrow or gear heavily can come unstuck when markets fall, as losses will be accentuated.

It is ironic that the mainstream international generalists are falling out of favour just as the unit trust industry is championing the global cause. The lack of commission has long been blamed for lack of adviser demand for investment trusts but maybe the move towards fees will stop the rot.

They remain ideal long-term core holdings. Not only does investment trust performance match their mutual counterparts, they are also cheaper. The total expense ratios (TERs) are often below 1 per cent while TERs on unit trusts are often in excess of 1.7 per cent.

Investment trusts have stood the test of time and they are adapting to the 21st Century. The problems of discounts are being addressed while new rules on corporate governance are shaking up boards that have become lax in their responsibilities. Several trusts have changed their election process in response to the new code.

The Association of Investment Trust Companies is now known as the Association of Investment Companies. The name change rubber-stamps the industry’s sea change. It probably will not faze the AIC that investment trusts are never destined to be for the masses but so long as they continue to generate decent returns, it will not bother those investors with nous to invest in them either.

Paul Farrow is deputy money editor at The Sunday Telegraph

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