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The NAV lark

There is much talk that the RDR will herald a new dawn for investment trusts but I remain sceptical. One of the main reasons I do not tend to look at investment trusts is that the managers only have a fixed pool of capital to work with. This is in contrast to unit trusts whose capital structure is variable and can rise or fall according to demand. This has a number of consequences for investors.

For the private investor who wants to buy a few thousand pounds of investment trust shares, there is usually enough availability to fulfil their need but problems arise for bigger deals, for instance, where organisations want to invest on behalf of a number of their clients.

Most investment trusts are relatively small. If an intermediary wanted to buy one or two million pounds worth of a trust, it could take several days to do so. A unit trust would simply create more units to accommodate the order the same day. If a big investor wants to sell, a similar situation arises.

So in a market that is moving all the time, an investor’s purchase or sale could take days or even weeks to complete. It is not easy to explain to an investor why it has taken this long to buy or sell an investment after they placed an order or that the price is likely to be different from what was originally quoted.

However, the very fact that invest-ment trusts are not a mass-market instrument creates opportunities for the savvy investor. The closed-ended structure of investment trusts means demand for shares (or lack of it) can lead to investment trusts trading at a premium or discount to their net asset value, that is, the intrinsic value of the fund’s assets.

Where shares are at a discount, it can mean the opportunity to pick up a bargain and make a profit if and when the discount narrows. These anomalies would probably disappear if investment trusts had wider appeal with big institutional investors and many trusts would probably end up on big premiums.

Some people believe the popularity of investment trusts will increase with the advent of the RDR when in theory more advisers will consider products that do not pay commission.

However, I do not believe this will necessarily be the case. While I like investment trusts and hold a number in my own portfolio, if you had a blank sheet of paper today and the task of designing a mass-market investment product, you would not come up with the investment trust model. On a large scale, it just does not work. This is little to do with commission and far more to do with liquidity and simplicity.

Some groups operating them try to get around the complication of excess demand by periodically issuing more shares, something Anthony Bolton has done with Fidelity China opportunities.

Meanwhile, Alliance Trust has been actively buying back its own shares in an attempt to reduce a big discount to NAV. Yet surely these are just cumbersome attempts to make the funds more like open-ended funds like unit trusts?

I do not think a change in financial services brought on by RDR will suddenly reignite interest in the investment trust world. The same underlying issues will persist.

For private investors, they offer some opportunities worth exploring, especially when the unpopularity of a trust leads to a particularly big discount to NAV but with more of the IFA community outsourcing investment decisions, investment trusts will remain a niche product used in more bespoke portfolios or by private clients.

Mark Dampier is head of research at Hargreaves Lansdown.


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