I love investment trusts.
I love them for their price; many of the best still have management charges of under 1%, which, these days, counts as very cheap indeed.
I love them for the way they can invest. Most funds, whatever they might say, are pretty short term in their outlook, but thanks to their closed structure, investment trusts can take a much longer-term view (they don’t have to buy and sell assets as investors move in and out of the fund as unit trusts have to). So the most interesting trusts are stashed full of fascinating small caps and unlisted companies.
I love the way they can borrow to invest; if you can trust the manager to get it right, that is nice.
But most of all, I love them for their overall performance. Alan Brierley of Collins Stewart points out that, in the ten years to 2009, the average investment trust outperformed the average unit trust in almost every sector. This outperformance isn’t a new thing. Back in the 1960s, The Statist magazine noted that, in the decade to 1967, the average trust made 175% even as global markets returned a mere 75%. Even in 1966, when markets fell 8%, investment trusts lost only 4%. It is an impressive record.
But if investment trusts are so great, why aren’t there more of them? Why is the unit trust market worth nearly £500bn and the investment trust market worth only £80bn? The Statist summed it up. There is, its editors said, a “limit to the disadvantages the investor is willing to assume to benefit from the best of professional management”.
And investment trusts do come with disadvantages. They are complicated: unit trusts just come with a price, but investment trusts come with a net asset value, a price and a discount or premium. That makes it hard for the ordinary investor to figure them out – something that isn’t helped by the fact that the sector does almost no effective marketing.
It also makes it hard for independent financial advisers (IFAs) to figure them out: 40% of IFAs told a survey a few months back that they didn’t recommend investment trusts because “their knowledge of them needs refreshing”. More tellingly, another 30% or so said they didn’t because there wasn’t anything in it for them. They can make good money flogging unit trusts but they don’t get paid a penny in commission for making people buy shares in investment trusts.
It is this last point that investment trust directors are clinging to. Why? Because, in 2013, the paying of commission to IFAs by unit trust providers is to be banned. So investment trusts will suddenly find themselves on a level playing field in terms of advice – the IFA will no longer have an incentive to ignore investment trusts. That means that everyone will immediately look to their virtues (price and performance) and pour into the sector.
However, I don’t think it is going to be quite so easy. This is partly because the removal of the commission bias won’t help with the knowledge bias. The average IFA is well over 50 and the odds are that he’ll be as ignorant of the workings of investment trusts in 2013 as he is now, regardless of how he gets paid.
But it is also because I worry that investment trusts are in danger of losing the thing that makes them most attractive: their low charges. The Association of Investment Companies proudly says that “almost a third of investment trusts have charges of less than 1% a year”.
That sounds good, but it isn’t: it means that two-thirds charge more, an average in fact of 1.76% a year. That’s up from 1.4% in 2008 and – if you take commission payments out of the equation (they’ll be gone in three years) – it looks higher than the average for unit trusts.
Worse, a large number of trusts are introducing performance fees. If you ask a fund manager about these, he will say that they are what investors want. But that isn’t true – performance fees are what managers want.
Terry Smith, the self-styled “straight talking” head of Tullett Prebon, explains why. If you had invested $1,000 with Warren Buffett at Berkshire Hathaway in 1965, your investment would have been worth $4.3m by the end of 2009. However, if he had charged a 2% management fee and a 20% performance fee on any gains, you would have ended up with only $300,000. The other $4m would now be in Mr. Buffett’s pocket. Performance fees make managers rich quick, not investors. If we have paid a management fee, haven’t we already paid the manager to do his best?
People in the financial industry are constantly asking me what people want. I always tell them the same thing: products that are simple and cheap. They clearly aren’t listening – as, mostly, they produce the opposite.
• This article was first published in the Financial Times