The Jonathan Davis column: A reversal of fortunes for managed funds

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Indy Lifestyle Online
Is the tide in the troubled investment trust sector at last starting to turn? It seems a good moment to ask the question, as it is now four years since the sector peaked in an orgy of new issues and some rather wild claims that trusts had solved their discount problem once and for all.

As so often happens, the launch of the most successful new issues ever seen marked the exact high point in the market. Since then, discounts have widened, the investment trust sector has fallen out of favour and the optimists have deserted the field in favour of the professional Cassandras predicting - as they have done so often before - the final demise of this venerable institution.

Two statistics measure the sector's fall from favour. One is that, rather then flowing in, money actually flowed out of the sector for the first time in several years. The second was that unit trusts had their best ever year, outselling investment trusts by a large margin.

In fact, according to the stockbroker Credit Lyonnais Securities, in their just published Annual Investment Trust Year Book, it was only in 1982 that unit trusts first matched investment trusts for funds under management. Now unit trusts have three times as much money invested with them as their older rivals. It looks like game, set and match to the unit trust business.

The other big irony is, that while it was the unit trust business which experienced the worst fund management scandal of recent years (the Peter Young debacle at Morgan Grenfell European in 1996, who managed to cost his employers more than pounds 300m in compensation to aggrieved investors), it is the investment trust sector which finds itself at the centre of the corporate governance and/or investment protection debate.

The wave of restructuring, fund manager changes and unitisations which has swept through the investment trust industry in the last year is a testament to the power that shareholders can wield over underperforming fund management groups. Yet who can remember the last time that anyone was able to persuade a lacklustre unit trust group into changing its ways? Shareholder power may not have amounted to much in the past, as far as investment trusts were concerned, but they do at least have some of it.

So can the sector win back the ground it has lost? Peter Walls, the Credit Lyonnais analyst, is one who thinks that it may be possible to see better times ahead.

Given that he was one of the first to warn that the good times of 1992 to 1994 could not last, his view that improvement may be on the way deserves notice. He is right to point out that investment trusts have many other things going for them - lower costs, and greater flexibility to name but two - if only the fund manager groups can get their act together and recognise the real demand for change in the way they operate.

All the main groups are now jumping on the shareholder-value bandwagon and are moving to end the most obvious abuses, such as multi-year management contracts and trust boards that are packed with place men.

The Chancellor's abolition of advance corporation tax (ACT) in last year's Budget may ironically be a godsend to the investment trust industry, as it makes it much easier to organise tax-efficient buy-back schemes which Mr Walls and others see as typical mechanisms for eliminating the discount and volatility which is the sector's Achilles' heel in marketing terms.

The value of share buy-backs is that they should put a floor under the average investment trust discount. Discounts have already narrowed slightly from their low point last year, and Mr Walls believes there is scope for the average discounts to fall to around 8 to 9 per cent.

That will be a disappointment to bargain hunters, who see discounts as a buying opportunity rather than an inherent defect of investment trusts, but it should do something at least to level the competitive playing field against the all-conquering unit trusts.

Unit trusts have many virtues, but it remains a mystery why they can get away with charging quite so much more than investment trusts - both in up-front costs and annual management fees - and still wipe the floor with the competition.

Selling commissions to intermediaries is clearly one reason, and it is interesting to note that Rod Birkett, who runs Fleming Trust Management, argues that investment trusts should raise their fees to allow them to pay commissions to independent financial advisers and other intermediaries. That is a brave idea, but my sense is that growing consumer awareness will eventually lead investors to start seeing the attractions of investment trusts once more.