Investment and unit trusts: another happy coalition?

James Budden of Baillie Gifford says the RDR may see closed-ended funds in guided architecture and on fund recommendation lists alongside open-ended funds.

It should have happened years ago. They have so much in common, being collective funds, on the whole aimed at retail investment. But somehow investment trusts and unit trusts have been seen as completely different with unit trusts filling the mainstream and investment trusts sitting in the margins.

Blame the media! It is not all their fault, yet the inability of fund performance companies to bring together the industry in a way that both approaches may be compared and rated together has hindered the appreciation of investment trusts’ superior returns to shareholders.

In addition, trade and consumer publications persist in separating these collectives. They publish specialist sector pages for investment trusts in the way they do for hedge or property, as if they were separate asset classes. Meanwhile, any general reporting on equity fund investment concerns just unit trusts without qualification. The logic behind this state of affairs is twisted and the future in the form of RDR suggests an unravelling ahead.

Trust ups and downs

Traditionally journalists, IFAs and opinion makers have given the investment trust sector a variety of labels, such as unloved, in decline, friendless, antiquated, opaque and more recently made up of ‘fuddy duddies’. As in many cases, there is no smoke without fire, and the strap line of “the city’s best kept secret” was met with smug smiles of satisfaction by those in the industry for many a year until the institutional investors voted with their feet.

Things have changed over the past 10 to 15 years for investment trusts: the tech bust, split capital trusts, the ITs campaign and, more recently, the financial crisis have seen some downs among the ups. But the sector is now in rude health. Its global flagships have morphed from index huggers into diverse and resolutely active equity options with performance to match. Market-leading specialist funds have sprung up across a spread of asset classes. Even the great icons of the open-ended world in Woodford and Bolton have hopped over the fence.

RDR the matchmaker?

RDR may bring unit and investment trusts together. At its centre is the removal of commission bias which, in theory, should lead to factory-gate pricing for product providers, and the end of payments between these providers and intermediaries.

Investment trusts have never paid commissions to IFAs except through savings plans and ISAs. A share does not have the ability to incorporate an annual charge in the way that a unit can. So this is not much of an incentive to purchase. Couple that with management groups’ preference to spend money marketing their proprietary funds rather than closed-ended trusts they might manage and you get a very bumpy playing field.

RDR should level out this inequality. IFAs should be looking ‘whole of market’ for investment options in the future and platforms should list investment trusts alongside unit trusts to facilitate this approach. This must offer greater opportunity for sober comparison, and even the inclusion of closed-ended funds in guided-architecture and on fund recommendation lists alongside open-ended funds.

However, a level playing field does not guarantee success. This has to be earned by promoting investment trusts and dispelling the myths around them. This is an area that does not come naturally to investment trust boards that are generally unwilling to spend shareholder funds on marketing funds which by their nature are unlikely to grow in size. But if intermediaries are not aware of particular investment trusts and their advantages how can they be expected to buy them on behalf of their clients?

So it falls to trust boards and trust managers to highlight the sector’s strong comparative performance record against unit trusts and to make sure IFAs recognise who the champions are in the way they would across the world of OEICs.

Breaking down misconceptions

Investment trusts must break down the misconceptions they are complicated, more risky and difficult to buy. An investment trust simply has shares, rather than units. It is a company that buys shares in other companies. It is ironic the majority of investment advertising in consumer personal finance publications concerns investment trusts. They are happy to sell direct to the investor, while many intermediaries consider them suitable only for the most sophisticated clients.

The idea that investment trusts are more risky than unit trusts centres on their use of gearing and the volatility of the discount. These can be valid issues for the unwary. Investment trusts may borrow money secured against their assets like any other listed company. Logic would suggest that if you invest in stock markets you believe that over time markets will go up.

Therefore, an element of gearing would be a good thing as it enhances returns. However, more often than not, gearing is viewed as a negative.

Similarly, discounts are considered a threat, rather than an opportunity. A discount on a trust offers the ability to pick up assets for less than they are worth, while enjoying the full benefit of any earnings from those assets. Also, there is a chance that discounts could reduce over time, thus adding to share price return. A knowledgeable investment adviser steers their clients towards the opportunities afforded by gearing and discounts. Finally, popular trusts and the ones you would want to use have good daily liquidity and can be bought and sold as competitively as many other constituents of the FTSE All Share index.

Investment trusts also have some distinct advantages over unit trusts. They tend to be cheaper. For example, Scottish Mortgage Investment Trust has a TER of less than 0.6% – successful active management at index prices. Investment trust managers can afford to take a truly long-term approach, while unit trust counterparts may be forced to sell favoured stocks when redemptions appear. Much maligned they may be, but investment trust boards offer strong corporate governance and align the interests of the shareholder and the trust. And then there is performance – your average investment trust has returned 63.4% over five years (to 30/04/10), against 46.3% produced by the unit trust sector (AIC MIS 30/04/10).

This coalition of investment trusts and unit trusts is coming, and not before time. Clients and investors should be always given the best chance of decent returns on their money. In some cases this might come from a unit trust while in others it might be an investment trust. It could be a blend of both. We live in a brave new world of togetherness and in this case at least we have a coalition that can prove universally popular and prosperous.