The principles behind collective investment are as simple and sound today as when Foreign & Colonial launched the first investment trust in 1868. Small investors whose savings are too modest to provide a reasonable spread of shares within a directly acquired portfolio - because of the costs involved and the insignificant size of the resulting holdings - can achieve the same end by pooling their money with other savers.
A management company like F&C or M&G can gather all these small savings together in a "trust" which then has substantial enough sums to invest directly and cheaply in shares, bonds or property. The trust structure offers the added advantage that it pays no capital gains tax (CGT), allowing it to trade its portfolio freely, where an individual with substantial profits on an investment might be deterred by tax considerations. (Investors are liable for CGT on any gains when they cash in their holding, however, unless they invest through a PEP).
Of course, the investor also hopes that a professional fund manager who dedicates most of his or her waking hours to the subject will also provide a superior service. Sadly this is not always so.
Figures from Micropal, a performance measurement company, show the extent of the disparity. A "unit holder" in one of the 159 unit trusts whose objective is to achieve capital growth from UK equities would have seen his or her savings rise by just short of 19 per cent on average last year. While not a bad result by most standards, Micropal says it would still have lagged the rise in the FT-SE All-Share index (the basket of 874 shares meant to be a representative sample of the whole market) by 4 percentage points. If you went into a unit trust to tap the wits of the best brains and outperform other investors, there is a better-than-even chance you would be disappointed.
The story is similar with investment trusts, which once had the edge on unit trusts in terms of cost and performance and because they could boost returns using borrowed money. Micropal shows that the best-performing of the 13 investment trusts seeking capital growth from UK shares, Fleming Enterprise, grew nearly 25 per cent on the year, well ahead of the market. But the worst - Welsh Industrial - would have lost you over pounds 30 for every pounds 1,000 invested.
There are several problems. Fees, particularly the typical 5 to 6 per cent initial fee when buying into a unit trust, are a drag on performance. Index-tracking funds, the increasingly popular trusts meant to do no more than match the rise or fall in the overall market, provide some illuminating lessons. To equal the All Share index to the middle of December, a tracker fund would have to have been up a little over 23 per cent. The best performer, Legal & General's UK index, with no initial charge, came close, but Morgan Grenfell's tracker fund, charging 5 per cent, could not even make it above 15 per cent last year. Investors paying initial fees of between 3 and 6 per cent and ending up with a markedly worse performance than the market should be asking their fund managers what they are up to.
Another problem with "collective" investment vehicles is that with 1,687 unit trusts and 350 investment trusts on the market, they are nearly as numerous as the shares they invest in. This means some are highly specialised, only investing in one industry or geographical area, which increases risks. Had you invested in the average trust specialising in the Far East last year, you would have lost about a third of your money. Had you gone into certain individual country funds you could be facing a loss of over 80 per cent.
Even so, carefully selected trusts (and, increasingly, Oeics) can be a useful way for more sophisticated investors to gain safer access to higher-growth areas. This applies in particular to the relatively new venture capital trusts (VCTs), which put investors into the high-risk area of venture capital while also gaining lucrative tax breaks.
For most people a low-cost tracker fund within a PEP was an excellent investment in 1997. These should probably be the preferred home for the low-risk part of most portfolios. More sophisticated investors can dabble in specialised funds, but beware - the risks can be substantial.
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