The investment trust sector is going through a transition period that could determine its future for years to come. But few experts believe the retail market will hold closed-end vehicles in any higher regard once the flurry of activity comes to an end.
Being subject to the laws of natural selection, investment trusts are constantly in a state of flux. If demand for a sector falls, the discounts of trusts within it will often widen, exposing them to the risk of attack from aggressive shareholders who will push for them to wind up.
But since the splits' debacle, trusts have also been subjected to corporate governance clampdowns, criticism of their structures and rapidly changing investor demands. The question is whether their efforts to overcome these challenges will have any impact on the retail market. Can investment trusts ever hope to compete with unit trust and Oeics?
One industry source says: “In many ways, trusts are superior investment vehicles and they often appear at the top of performance charts. But really, investors need to know something about the stockmarket and therefore they should not be seen as mass-market products.”
Simplicity is key for retail products and this is where investment trusts fall down. Little can be done to alter their fundamental structure but efforts are being made to mitigate the effects of their complexity, shown by the AITC's recent bid to narrow discounts by changing the way that net asset values are calculated.
Individual activity has largely involved boards becoming more active in replacing underperforming managers and updating mandates to better reflect investors' changing appetites. Hence, there has been a widely welcomed shift away from closet tracking towards focus funds which seek absolute returns.
Iimia head of investment trusts Nick Greenwood says: “It should be massively beneficial to the industry. In the old days of closet benchmarking, there was little point in having the protection of a closed-end structure. Focus funds can get into trouble very quickly but as investment trusts this cannot really happen.”
If a unit trust manager runs into problems – usually when stock picks go awry – redemptions increase and he or she is forced to keep selling, something that is usually ruthlessly exploited by the market. But when an investment trust manager hits difficulties, the sole consequence is that the trust's discount widens, a problem usually countered by the buy-back of shares, which increases demand by reducing supply.
This shift towards absolute return trusts is liable to be particularly beneficial to fund-of-funds managers which, as a result of Ucits 3, will be able to buy into trusts unconstrained. They will also be able to take advantage of the new mixed funds, which allow managers to invest in both open-ended and closed-ended vehicles.
Isis director, head of communications and strategy Jason Hollands says: “Over time, we may start to see Fof managers become big purchasers of trusts. They may decide they would rather access the performance of a manager they like through a trust rather than an Oeic because of the discount.”
Hollands believes there has been a “silent revolution” among generalist trusts, some of which, such as Witan, have adopted a multi-manager approach. A handful are even gaining exposure to hedge funds, which is the type of change Hollands says will help some trusts shake off their dusty image among retail investors.
Nevertheless, the industry has a massive job on its hands trying to persuade the retail market that trusts are superior to Oeics and unit trusts. Previous efforts to market trusts direct to consumers, specifically the Its campaign, have been met with bemusement and indifference.
Aberdeen Asset Management consultant Jonathan Polin says: “The Its campaign spent a lot of money for no net gain. The problem was that it was generic – it was like marketing beans but with no brand. It did the industry a disservice because trusts need to target investors in a more specific way.”
Polin believes that, when it comes to the retail market, there are fundamental problems with trusts which are unlikely to be resolved. With depolarisation concentrating distribution, he says trusts could lose out as the life products of providers likely to multi-tie will fit better with open-ended funds rather than closed-ended funds.
What can trusts do? All experts agree that education is crucial. Without it, trusts stand no chance of regaining in the retail market what they have lost in the institutional arena. But most people still equate investment trusts with the splits disaster, although the AITC believes this is beginning to change.
Communications director Annabel Brodie-Smith says: “Obviously, it has had an impact but we have worked hard to contain it to those splits affected. With changes to the listing rules, the AITC code of corporate governance and increasing transparency, we think confidence is returning to the splits sector.”
What is not helping is the ongoing compensation saga. The FSA has been criticised for its grandstanding but the providers involved have offered over £200m less than the regulator is demanding. Now talks have broken down, many of the groups are set to become embroiled in protracted legal battles which will only serve to remind the public of a hugely damaging episode in the sector's history.
But there are still grounds for optimism. The trust structure, complicated as it is, boasts a level of flexibility which few vehicles can match. For example, we could see more boards introduce discount control mechanisms, much as Finsbury growth has done.
But for all this innovation, trusts still face an uphill struggle in the broader retail market, which is moving increasingly towards simple-to-understand products, which trusts will never be.