Private buyers sought for investment trusts

Flexible pricing and listing on the stock market make these vehicles a low-cost method of professional management
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The Independent Online

Those who know me - or read my column on a regular basis - will know that I am a great fan of investment trusts.

Those who know me - or read my column on a regular basis - will know that I am a great fan of investment trusts.

True, they do not necessarily suit everybody and some trusts need to be treated with caution. But by and large they provide a way of achieving professional management at a lower cost than through other investment funds. So, if they are such good value, why is it - I was asked - that their shares usually stand at a discount to underlying assets. I can explain that, I retorted. Several wet towels later I realised it was not quite so easy.

First a brief history lesson. Investment trusts are the longest established of the collective investment funds available in this country. The earliest emerged in the middle of the 19th century and it was not until nearly a 100 years later, in the 1930s, that unit trusts came on the scene.

The first investment trusts were more like venture-capital vehicles, financing railways in Argentina or other worthy projects. As time went on, more trusts were formed and a wide variety of investment opportunities became available.

Many of the first investors in these trusts were the pension funds and insurance companies that now control the bulk of the domestic stock market. Part of the attraction to these institutional investors was trusts' expertise in overseas markets.

Exchange Controls remained with us from the start of the Second World War until the beginning of the Thatcher administration and, although the restrictions that these imposed were eased, foreign investing was still cumbersome and expensive.

Investment abroad has become easier, while the professional investment community now prefers to make its own decisions. It is less keen to hold investment trust shares and the community has become a natural seller of these shares.

Private investors are being encouraged to fill the gap by the Association of Investment Trust Companies, the investment trust movement's trade body. The AITC launched an advertising campaign to try to convince the public of the virtues of investment-trust share ownership as discounts started to widen. And why was this happening?

Because the shares of an investment trust are traded on the stock market and are priced according to supply and demand, the relationship with the value of underlying assets can change, so natural sellers in the form of the investing institutions can make a difference. At times of great market uncertainty, discounts can widen considerably as market makers lower prices to the point at which buyers will step in. This is not the case with unit trusts, where a formula is applied to determine the price at which units can be bought and sold, although there exists a degree of pricing flexibility of which many private investors are unaware.

It is not all about discounts. The ability of these shares to fluctuate regardless of asset performance can result in premiums arising. When emerging markets became fashionable, Mark Mobius's Templeton Investment Trust stood well above the value of underlying assets, partly as there was a limited choice to investors, but also because Dr Mobius was highly rated by the professional investment community.

While the level of discounts generally seems too high, the reality is that some discount for the average trust is always likely to remain. This reflects the greater volatility that these shares can enjoy and the absence of a guarantee you can sell in the market if suddenly the whole world turns bearish. Still, there are plenty of good trusts standing at discounts in excess of 10 per cent - trusts that can demonstrate good long-term performance. Moreover, investment trusts now have the ability to buy in their own shares, as can other quoted companies, which should maintain the downward pressure on discounts.

So if you really want to understand why you can buy a £100 worth of assets for £85, you must appreciate that there are plenty of willing sellers. While the market will price in a degree of risk, long-term investors may not necessarily find that an issue. Many trusts now build in a guaranteed redemption date, so you know you will receive back asset value at some stage in the future. Investment trusts are a good way of obtaining exposure to the stock market. But remember to take good professional advice before buying.

Brian Tora is the Chairman of the Greig Middleton Asset Allocation Committee

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