Personal Finance: Trust in us: it's not a wind-up

INVESTMENT TRUSTS are a cheap way of buying a package of professionally managed shares at a discount to their market prices, according to their supporters, and a dying investment form, according to their critics.

So do investment trusts have a future? Part of the answer to this may have been given last month when Mercury's European Privatisation Investment Trust (MEPIT) survived a break-up attempt . Speculators bought up almost 5 per cent of the shares issued by the pounds 1bn trust, arguing it had underperformed, and hoping to rally support among institutional shareholders for a wind- up. If successful, they stood to gain the difference between the price they paid for their shares, and the trust's underlying "net asset value" which represents the current market value of all the trust's holdings.

There is nothing new about "arbitrage" activity of this kind. It allows a very quick profit to be made as a result of two characteristics common to investment trusts.

Firstly , their share price is a function of investor demand on the Stock Exchange, not of the value of the assets that they own. This means shares in a trust can be bought at a "premium" when the price of the trust's own shares stands above its net asset value (NAV) of the shares the trust holds, or at a "discount" when the price stands below.

A second characteristic is that shareholders with more than 5 per cent of a trust can put forward a motion to wind it up at its annual general meeting. Around two thirds of shares in UK investment trusts are owned by institutional investors. Many of these are pulling out of investment trusts, and using their own fund managers to invest directly into the same assets.

"Offered the prospect of an immediate cash profit, some of these institutions will go with the speculators, unlike private investors who tend to be very loyal, keeping their holdings over the medium to long term," observes Ian Barby, head of the investment trust division at Mercury.

These conditions have created an excess of supply over demand for some types of investment trust share. Prices have fallen and discounts widened. Trust managers need to find new money, and the Association of Investment Trusts(AITC) is proposing a pounds 27m marketing plan aimed at private investors.

But investment trusts have proved less popular with us than alternatives like unit trusts. The result is a net outflow of capital, some pounds 1.6bn since 5 April from the sector as a whole. Meanwhile trust managers are trying to defend themselves by "buying back" shares in their trusts, aiming to reduce discounts and improve shareholder value.

MEPIT is a case in point. Its shares were trading at just 110p early last December, but now stand around 167p. Meanwhile the discount to the NAV has narrowed from 18 per cent to just 9 per cent. This makes it look as if the "arbies" did other shareholders a favour, but Mr Barby, is not so sure.

"The fund needed to change its investment remit, and we announced this was to happen two days before anyone knew of their attempt to break it up. We have also been buying back our shares, and this year will again buy the maximum permitted amount of 14.99 per cent. Arbitrageurs are out for short term profit, while we are catering to long term investment needs."

Not everyone agrees with this view. Jeremy Batstone of Natwest Stockbrokers thinks that, "the IT sector will shrink before it grows, and arbitrage is a stimulus to the poorer performing management teams, running trusts which lag behind their sectoral equivalents."

All of this opens up some tempting prospects for the private investor. Why not buy into trusts on wide discounts and wait for arbitrage to do its work? "Not that easy," warns Mr Batstone. "You must be very careful about the true NAV of a fund." To reach this, deduct the winding up cost which could be 4 or 5 per cent. So a paper discount of 10 per cent might in cash terms be worth only half that, equivalent to the bid/offer spread on a unit trust.

"Watch out also for the debt owed by a trust .Some sectors, such as property trusts, borrow over the medium term and must pay a cash penalty on early redemption if the trust is wound up." Institutional investors, with blocks of shares, are nearly always the key to whether a trust survives or is broken up.

Do investment trusts have a future? "Only the fittest will survive," says Mr Batstone, "but don't buy without first doing some serious research."

Start your day with The Independent, sign up for daily news emails
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

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

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Claims Administrator

£16000 - £18500 per annum: Recruitment Genius: This is an excellent opportunit...

Recruitment Genius: Senior SEO Executive

£24000 - £28000 per annum: Recruitment Genius: A Senior SEO Executive is requi...

Recruitment Genius: Online Customer Service Administrator

£16000 - £18000 per annum: Recruitment Genius: An Online customer Service Admi...

Recruitment Genius: Digital Marketing Executive

£18000 - £22000 per annum: Recruitment Genius: This global, industry leading, ...

Day In a Page

Fishing for votes with Nigel Farage: The Ukip leader shows how he can work an audience as he casts his line to the disaffected of Grimsby

Fishing is on Nigel Farage's mind

Ukip leader casts a line to the disaffected
Who is bombing whom in the Middle East? It's amazing they don't all hit each other

Who is bombing whom in the Middle East?

Robert Fisk untangles the countries and factions
China's influence on fashion: At the top of the game both creatively and commercially

China's influence on fashion

At the top of the game both creatively and commercially
Lord O’Donnell: Former cabinet secretary on the election and life away from the levers of power

The man known as GOD has a reputation for getting the job done

Lord O'Donnell's three principles of rule
Rainbow shades: It's all bright on the night

Rainbow shades

It's all bright on the night
'It was first time I had ever tasted chocolate. I kept a piece, and when Amsterdam was liberated, I gave it to the first Allied soldier I saw'

Bread from heaven

Dutch survivors thank RAF for World War II drop that saved millions
Britain will be 'run for the wealthy and powerful' if Tories retain power - Labour

How 'the Axe' helped Labour

UK will be 'run for the wealthy and powerful' if Tories retain power
Rare and exclusive video shows the horrific price paid by activists for challenging the rule of jihadist extremists in Syria

The price to be paid for challenging the rule of extremists

A revolution now 'consuming its own children'
Welcome to the world of Megagames

Welcome to the world of Megagames

300 players take part in Watch the Skies! board game in London
'Nymphomaniac' actress reveals what it was really like to star in one of the most explicit films ever

Charlotte Gainsbourg on 'Nymphomaniac'

Starring in one of the most explicit films ever
Robert Fisk in Abu Dhabi: The Emirates' out-of-sight migrant workers helping to build the dream projects of its rulers

Robert Fisk in Abu Dhabi

The Emirates' out-of-sight migrant workers helping to build the dream projects of its rulers
Vince Cable interview: Charging fees for employment tribunals was 'a very bad move'

Vince Cable exclusive interview

Charging fees for employment tribunals was 'a very bad move'
Iwan Rheon interview: Game of Thrones star returns to his Welsh roots to record debut album

Iwan Rheon is returning to his Welsh roots

Rheon is best known for his role as the Bastard of Bolton. It's gruelling playing a sadistic torturer, he tells Craig McLean, but it hasn't stopped him recording an album of Welsh psychedelia
Russell Brand's interview with Ed Miliband has got everyone talking about The Trews

Everyone is talking about The Trews

Russell Brand's 'true news' videos attract millions of viewers. But today's 'Milibrand' interview introduced his resolutely amateurish style to a whole new crowd
Morne Hardenberg interview: Cameraman for BBC's upcoming show Shark on filming the ocean's most dangerous predator

It's time for my close-up

Meet the man who films great whites for a living