Geared up for better long-term performance

Gearing and discounts are two factors that offer investment trust investors the potential for better long-term performance and value for money.

"Gearing", which is simply a technical term for borrowing, is one way of enhancing the performance of the underlying assets of a trust. The funds can take out loans to buy more assets in the expectation that these will rise in value.

The loan has to be repaid at a later date but the more total assets rise in value the greater the proportional benefit to shareholders, because the value of the loan remains fixed. Effective gearing relies on the expertise of the manager. In rising markets, it enhances shareholders' returns but in falling markets it has a correspondingly negative effect. Good underlying performance is the most important factor in driving up the price of a trust's shares, so investors benefit from successful gearing.

Investment trust shares are valued in the stock market according to supply and demand. Most trade at a price that is lower than the underlying net asset value per share (NAV). This is called "trading at a discount".

The discount is the difference between the NAV of the assets held in the trust and its share price, calculated as a percentage of the NAV. For example, if the share price is 90p and the NAV is 100p, the discount is 10 per cent. If the share price rises above the NAV, it is trading at a premium. This is rare but it can occur when there is particularly high demand for the shares of a trust.

The investment trust industry's average discount currently stands at around 12 per cent. But in the 1970s, discounts of well over 30 per cent were common. They narrowed significantly after the late 1980s, when the tax regime became more favourable and low-cost investment trust savings schemes and PEPs were launched. As a result, demand for the shares increased.

The narrowing of discounts to single figures in the early 1990s, however, encouraged new launches. This inevitably led to over-supply. Investment trust companies have a fixed number of shares in issue which they cannot readily reduce or increase in the way unit trusts can. When supply outstrips demand, discounts widen.

Investment trusts have no control over the discount but their boards of directors have a duty to shareholders to address poor performance, and they can do this in a number of ways. Savings schemes and PEPs, for example, have encouraged demand and enable investors to buy investment trust shares on a regular monthly basis or with an occasional lump sum at favourable rates.

Investment trusts can buy back some of their shares to reduce supply, although their ability to do this is limited. The Association of Investment Trust Companies is exploring ways of making buy-backs easier for investment trusts.

If asset performance is poor, the board may change the manager. If share price performance is poor, the board could wind up the company to enable shareholders to realise their investment nearer to the NAV. Alternatively, they could unitise, changing to a unit trust; restructure, possibly into a split capital trust; or maybe change the investment policy.

Action may be forced on a board. An investment trust on a wide discount, with an attractive portfolio of investments, may find itself the subject of a takeover bid. While a takeovers may enable shareholders to realise investment at a value close to the NAV, the costs of the liquidation will reduce their return. So shareholders must weigh up the pros and cons of a possible quick profit today compared with the potentially greater, but longer-term, benefits of continuing to hold the investment.

Such corporate activity does not signify that the investment trust industry is coming to an end, as some critics have predicted. It's just the market's way of restoring balance when supply and demand are out of line.

So are discounts automatically a bad thing, as is often assumed? If you can buy a good quality product for lower than the retail price, you don't hesitate, and the same principle applies to investment trusts. If the investment trust has good underlying asset performance, it meets your investment criteria and is trading at a discount, consider it a buying opportunity.

Over the long-term, the discount pales into little significance where performance is concerned. And, historically, investment trusts have delivered excellent performance.

- Annabel Brodie Smith

Free information on investment trusts, including a factsheet on Investment Trust Discounts, is available from the AITC on 0171-531 5222.

n Annabel Brodie Smith works for the Association of Investment Trust Companies.

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

News
peopleMathematician John Nash inspired the film Beautiful Mind
News
Richard Blair is concerned the trenches are falling into disrepair
newsGeorge Orwell's son wants to save war site that inspired book
Life and Style
Audrey Hepburn with Hubert De Givenchy, whose well-cut black tuxedo is a 'timeless look'
fashionIt may be a paradox, but the industry loves it
Arts and Entertainment
The pair in their heyday in 1967
music
Life and Style
fashionFrom bathing dresses in the twenties to modern bikinis
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Guru Careers: Software Developer / C# Developer

    £40-50K: Guru Careers: We are seeking an experienced Software / C# Developer w...

    Neil Pavier: Management Accountant

    £45,000 - £55,000: Neil Pavier: Are you looking for your next opportunity for ...

    Sheridan Maine: Commercial Accountant

    £45,000 - £55,000: Sheridan Maine: Are you a newly qualified ACA/ACCA/ACMA qua...

    Laura Norton: Project Accountant

    £50,000 - £60,000: Laura Norton: Are you looking for an opportunity within a w...

    Day In a Page

    Abuse - and the hell that came afterwards

    Abuse - and the hell that follows

    James Rhodes on the extraordinary legal battle to publish his memoir
    Why we need a 'tranquility map' of England, according to campaigners

    It's oh so quiet!

    The case for a 'tranquility map' of England
    'Timeless fashion': It may be a paradox, but the industry loves it

    'Timeless fashion'

    It may be a paradox, but the industry loves it
    If the West needs a bridge to the 'moderates' inside Isis, maybe we could have done with Osama bin Laden staying alive after all

    Could have done with Osama bin Laden staying alive?

    Robert Fisk on the Fountainheads of World Evil in 2011 - and 2015
    New exhibition celebrates the evolution of swimwear

    Evolution of swimwear

    From bathing dresses in the twenties to modern bikinis
    Sun, sex and an anthropological study: One British academic's summer of hell in Magaluf

    Sun, sex and an anthropological study

    One academic’s summer of hell in Magaluf
    From Shakespeare to Rising Damp... to Vicious

    Frances de la Tour's 50-year triumph

    'Rising Damp' brought De la Tour such recognition that she could be forgiven if she'd never been able to move on. But at 70, she continues to flourish - and to beguile
    'That Whitsun, I was late getting away...'

    Ian McMillan on the Whitsun Weddings

    This weekend is Whitsun, and while the festival may no longer resonate, Larkin's best-loved poem, lives on - along with the train journey at the heart of it
    Kathryn Williams explores the works and influences of Sylvia Plath in a new light

    Songs from the bell jar

    Kathryn Williams explores the works and influences of Sylvia Plath
    How one man's day in high heels showed him that Cannes must change its 'no flats' policy

    One man's day in high heels

    ...showed him that Cannes must change its 'flats' policy
    Is a quiet crusade to reform executive pay bearing fruit?

    Is a quiet crusade to reform executive pay bearing fruit?

    Dominic Rossi of Fidelity says his pressure on business to control rewards is working. But why aren’t other fund managers helping?
    The King David Hotel gives precious work to Palestinians - unless peace talks are on

    King David Hotel: Palestinians not included

    The King David is special to Jerusalem. Nick Kochan checked in and discovered it has some special arrangements, too
    More people moving from Australia to New Zealand than in the other direction for first time in 24 years

    End of the Aussie brain drain

    More people moving from Australia to New Zealand than in the other direction for first time in 24 years
    Meditation is touted as a cure for mental instability but can it actually be bad for you?

    Can meditation be bad for you?

    Researching a mass murder, Dr Miguel Farias discovered that, far from bringing inner peace, meditation can leave devotees in pieces
    Eurovision 2015: Australians will be cheering on their first-ever entrant this Saturday

    Australia's first-ever Eurovision entrant

    Australia, a nation of kitsch-worshippers, has always loved the Eurovision Song Contest. Maggie Alderson says it'll fit in fine