Why it pays to look at investment trusts

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The Independent Online
DO INVESTMENT trusts have a future? Part of the answer to this may have been given recently when Mercury's European Privatisation Investment Trust (Mepit) survived a break-up attempt.

Arbitrageurs bought up almost 5 per cent of shares issued by the pounds 1bn fund in the hope of being able to win a vote in favour of winding it up. If successful, they stood to gain the difference between the price they paid for their shares, and the fund's underlying "net asset value" (NAV).

Activity of this kind allows a very quick profit to be made as a result of two characteristics common to investment trusts. First, their share price is a function of investor demand not of the value of the assets that they own. 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 which are pulling out of the sector. "Offered the prospect of an immediate cash profit some of these will go with the arbitrageurs, unlike private investors who tend to be very loyal," says Ian Barby, head of the investment trust division at Mercury.

Even so, investment trusts have proved less popular with us than alternatives like unit trusts. "Ignorance is putting savers off an excellent, low-cost investment vehicle," says Mr Barby.

Meanwhile, trust managers are trying to defend themselves by buying back shares to improve shareholder value. Mepit is a case in point. Its shares were trading at just 110p early last December, but now stand around 167p. The NAV has narrowed from 18 to just 9 per cent.

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 Jeremy Batstone, of NatWest Stockbrokers. "For a start you must be very careful about the true NAV of a fund." To calculate 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 amount. Institutional investors holding large blocks of shares, will nearly always be the key to whether a trust survives or is broken up. Mr Batstone says: "Look wherever they are likely to pull out - underperforming generalist trusts, and those holding assets in more than one investment sector."

Examples here include the Far East and Japan, with a trust like Govett's Asian Recovery fund holding assets in both sectors. "Institutions now regard these sectors as mismatched and treat them separately," he says.