It's time to consider an unpopular option

Investment trusts are out of favour but good value, writes Tony Lyons

Investment trusts had a rough ride in 1998 but if you are looking for a long-term home for your last PEP or new ISA money, these stock market funds are a good bet. They have been held back from mass popularity because they are more complicated than their near-rival, unit trusts, and have also suffered because they don't pay much (or any) commission to financial advisers. An IFA who depends on commission to make a living is unlikely to suggest an investment trust in preference to a unit trust.

But it is precisely this complexity and low-cost structure that makes investment trusts an excellent home for long-term savings.

Investment trusts are companies listed on the stock market. They are run by boards of directors and have a set number of shares which are traded on the market (unlike unit trusts which create and cancel units as people buy and sell them).

The share price of an investment trust is determined by demand in the stock market. Prices are often below the value of the underlying company shares held in the trust, which means the trust is trading "at a discount".

The average discount is currently around 14 per cent, which means the investor can buy pounds 1 of shares for 86p. Not only that, but the dividends paid out will be based on the full pounds 1. And once the new financial year starts on 6 April, investment trusts will be able to arrange buy-backs for their shares.

The changes in advanced corporation tax (ACT) rules which come into force on that date may hit share dividends, but they have also freed the way for investment trust managers to purchase their own shares in the market. This could revitalise the industry, as it will reduce the over-supply of shares.

When the buy-backs start, investment trust share prices are bound to rise. Flemings, one of the largest management groups, is typical in that on 6 April all of its funds will be able to initiate buy-backs. In addition, the price of an investment trust can be spiced up by takeover rumours. There are a number of predators in the market.

Most investment trust PEPs have no initial charge - only the 0.5 per cent stamp duty paid on all purchases of ordinary shares - and the annual management charge is usually between 0.25 and 1 per cent. PEPs sometimes have an annual administration charge, starting at pounds 10 but usually around pounds 30 per fund. Compare this with actively managed unit trusts which usually have a 5 per cent initial charge and annual charges of around 1.5 per cent. A few even have extra administration fees.

Unlike unit trusts, investment trusts can invest in property and unquoted companies. They can even borrow money - this is called gearing. Managers will do this if they believe they can get a good return. "Investment trusts have so much going for them," says Simon Crinagh of Flemings, which has dropped its 1.5 per cent initial PEP charge for new investors. "Claverhouse, which invests in blue-chip shares, has been popular and is at a slight premium. Fleming Geared Growth trades at a 21 per cent discount."

For first-time investors, Simon Westwood of Henderson recommends a look at his stable's Witan and Electric & General Trusts. "These are long-established, consistent performers investing in blue chips. A bigger gamble could be Bankers, which follows an out-of-favour value in-vestment style, so it is on a large discount."

Investors happy to take a higher risk could look at smaller company funds, advises Jeremy Tigue, of Foreign & Colonial, while safety-first investors should look at the broad international trusts.

Most investors buy their investment trust PEPs directly from the managers. Some trusts pay commission and you can save this by buying through discount brokers.

If you want to find out more about investment trust PEPs, the Association of Investment Trust Companies has free fact sheets.

n Contacts: Association of Investment Trust Companies, 0171-431 5222; Fleming Investment Trust Management, 0500 500324; Foreign & Colonial, 0171-825 5300; Henderson, 0800 212256; Kohn Cougar, 0117-946 6384.

RECOMMENDED TRUSTS

Roddy Kohn, of Kohn Cougar, is a fee-charging IFA . He particularly likes:

n Witan: "a good middle-of-the-road trust with long experience in international markets".

n Henderson TR Property: "buys property shares as well as taking direct stakes in property - something a unit trust cannot do".

n Henderson Strata: "a smaller company specialist".

n Gartmore European and Gartmore Smaller Companies: "good performers".

n F&C Enterprise: "invests in unquoted companies and has the best long performance record of all funds".