The debate surrounding unit trusts and investment trusts, and which is the superior investment vehicle, has raged throughout my whole career.
In most respects I haven't found the debate helpful. I believe investors should concentrate on taking the best from both.
The fact investment trusts can use gearing – borrowing money to invest – is usually an advantage over the long term. In rising markets it explains, at least in part, their better performance over unit trusts. Investors need to be aware though that performance can be driven by one-off factors, such as discounts narrowing; or even the share price moving ahead of the net asset value for the fund to trade at a "premium", to use a popular piece of investment-trust jargon.
Investment trusts are listed companies, making them slightly more complex than unit trusts. This shouldn't necessarily put investors off. Unit trusts, on the other hand, are said to be more expensive. I would argue after the ending of commission that unit trusts will be cheaper than investment trusts. Remember too, some 62 per cent of investment trusts have performance fees, which can increase costs.
Those wanting to "dip a toe in the water" for the first time, could go out and buy Foreign and Colonial, Witan or a number of other good global investment trusts. Alternatively, you could leave it to an expert such as Peter Walls, who manages the Unicorn Mastertrust. Mr Walls has more experience than most when it comes to investment trusts. He started his career at Hoare Govett in 1976 and what he doesn't know about investment trusts you could write on a postage stamp.
Mr Walls combines an overall view of stock markets and the economy with his experience of individual investment trusts. His economic analysis often centres on capital flows into particular countries or regions. Looking at where investors are deploying cash gives him a broad sense of momentum. This is important because areas can suddenly become very fashionable.
At the individual trust level he looks at underlying portfolios, seeking those that offer good earnings per share growth and are investing in the next growth markets. Often in the investment trust world this can be done simply by looking at discounts and premiums. While discounts can indicate a poorly managed trust, they can also mean a deeply unfashionable and unloved sector – normally an excellent buying opportunity.
Conversely, when funds and sectors are trading at big premiums it is usually a signal markets are "overcooked". One area Mr Walls and I think looks stretched is the income space, or more specifically the alternatives for income space. Here we find infrastructure funds, often trading at 10 per cent plus premiums, still being promoted on the basis of a 5 per cent yield. These sorts of trusts are also raising lots of new money and this is a sector that he is tending to avoid right now.
Presently, Mr Walls has no strong views on stock markets and if anything he feels slightly cautious. He has therefore bought funds he feels offer downside protection. He cites Foreign & Colonial as an example. It is a large, liquid trust where he knows the company will buy back shares if the discount exceeds 10 per cent.
Investment trusts often get wonderful publicity from the financial media, but the sector has a marvellous ability to shoot itself in the foot as we saw in the emerging markets bull run of the 1990s and more recently in property, where the sector has gone from hero to zero and back in just a few years.
This fund has a remarkable performance track record, yet it is still only £10m in size. In many ways this is ideal for investment trusts where liquidity can be a major problem. Mr Walls believes the fund is more than capable of growing to a size of around £100m, but after more than a decade of excellent performance it still sits there at £10m. In my view this could make an ideal, one-stop shop for investors looking for some investment-trust exposure, with an experienced fund manager who knows his sector inside out choosing funds on your behalf.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial advisor and stockbroker. For more details about the funds included in this column, visit hl.co.uk/independent
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