Money: Good riddance to '97

Investment trusts suffered last year. Philip Middleton asks if things will get better
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The Independent Online
As investment trust managers contemplate 1998, they will be thinking that it can hardly be any worse than 1997. This past year, investment trusts have been faced with a deluge of bad publicity. Worse still, on average they have markedly underperformed the UK stock market.

The glory days of 1993, when new issues seemed to get bigger and bigger by the day (culminating in the much-hyped privatisation funds), are merely a fond memory. These days investors are asking for their money back, not giving managers new funds to run.

To complete the gloomy picture, the Government's proposed ISAs hardly look good news for the trust sector. Many trusts currently have a lot of their shares held in Peps. If the pounds 50,000 limit stays in place, there could be sellers of these stocks in 1999.

Why should 1998 be any better? Well, for investors, 1997 wasn't as bad as the opening paragraphs make it sound. Sure, trusts as a whole did underperform, but this is mainly because they had a large exposure to Asia and smaller companies at a time when large, international stocks were leading the charge. So, the first thing that the investment trust sector should have asked Santa for is a year when the rest of the world outperforms big US and UK stocks.

It is notoriously difficult to predict market movements. What may be more predictable is that the sector's share price performance beats that of the underlying assets. Why? At the moment, many areas that were once fashionable have fallen from favour. As a result, trusts that once traded at net asset value (NAV) or above are now on chunky discounts. If you can buy a trust on a discount of 15 per cent, you will be buying 100p worth of assets for 85p.

Of course, there's a catch. Although notionally you might own 100p of assets, you can't ring up the trust manager and demand your money. All you can do is sell your shares in the market. In theory, there is no limit to the size of the discount, just as there's nothing to stop a trust trading at twice net asset value. In practice, it is uncommon for a mainstream trust to trade on a discount of 20 per cent-plus for long. If it does, a predator may well take a stake and suggest politely to the managers that they "do something about the discount".

Where 1998 could be different is that, as well as converting into unit trusts, investment trusts have recently found that they can buy in their own shares. By doing this trusts improve their net asset value - they really are buying 100p of assets for 85p - and reduce the supply of shares. Eventually, the oversupply of shares must end, at which point prices should rise and discounts narrow.

Shareholders in the Far-Eastern trusts could do with some good news. Some of the best news available is that a large number of these trusts are now able to buy in shares without paying tax. Edinburgh Dragon - the biggest trust in the sector - has announced a huge buy-in programme. Murray Johnstone's Scottish Asian and Schroder Asia-Pacific are looking at doing the same, and we expect others to follow suit. Investors who want to buy into Asian markets should seriously consider one of these, or other large, quality stocks in the area such as Invesco Asia and Henderson TR Pacific.

For those who want a quieter life, there is a range of other trusts with good records available on attractive ratings. Foreign and Colonial is widely held by private investors, whom it has served very well over the years. However, 1996 was horrible for "Foreigns". Not only did its rating widen, partly because the trust came out of the FT-SE 100, but the assets didn't perform well. This year has seen the assets back on track, but the discount remains pretty wide.

Another stock that many people hold is Mercury European Privatisation Trust (Mepit). This has had a chequered share price performance, as it was launched right at the end of the 1993/4 new issue boom, and went from asset value to a discount in very short order. That said, the assets have performed well, and the trust has a buy-in programme about to come into force.

q Philip Middleton is an investment trust analyst at Merrill Lynch, a firm of City stockbrokers.