What kind of trends have you seen in the investment trust market presently?

In 2015, the majority of investment trust IPOs have been strategies which invest in illiquid assets. One example is Woodford’s Patient Capital Trust, launched in April, which invests in early-stage and early-growth companies. At Milford & Dormor Financial Planning Financial Planners, we often look at using investment trusts when investing in assets such as infrastructure where liquidity can be an issue, such as HICL and 3i Infrastructure, as the closed-ended structure is advantageous. However, we have chosen to avoid P2P lending which has received a lot of media attention recently.

In addition, investment trusts have been well placed to benefit from the recent changes to pensions and increasing demand for income as they have the ability to retain up to 15% income each year which enables them to distribute a more consistent income stream to investors over time. Furthermore, we have noticed that some investment trusts now tend to pay out dividends on a quarterly basis, which is attractive to investors from a cash flow point of view.

At Milford & Dormor Financial Planning Financial Planners, we favour some investment trusts with good yields for these reasons. City of London, for example, has had 49 consecutive years of dividend increases which is attractive for our clients; a large proportion of which are in retirement. Where a fund manager runs both an investment trust and unit trust version of the same fund, it is not uncommon for the yield on the investment trust to be significantly higher, such as Mark Barnett’s Edinburgh Trust (3.35%) vs Invesco Perpetual High Income (3.04%).

How is the sector performing?

To the decade before the end of 2014, investment trusts outperformed unit trusts in 12 out of 15 sectors. This emphasises the ability of fund managers to magnify long run returns by sensibly managing the level of gearing of their portfolios. Accordingly, as long term investors, investment trusts make up an important part of our investment process at Milford & Dormor Financial Planning Financial Planners. In addition, an investment trust for which there is also a unit trust version available can present an attractive arbitrage opportunity if it is trading at a discount to the underlying NAV, which can enhance long term compounded returns as well as the yield. Harry Nimmo, manager of UK Smaller Companies at Standard Life has an excellent long term track record, but due to some short term underperformance the investment trust version in our view currently offers good value given its 6% discount to NAV.

What sector within the Investment Trust space do you think has performed best? 

In the last few years, biotechnology/healthcare sectors have performed very strongly. For example, The Biotech Trust has returned 328% in the last 5 years. In our view, biotech/healthcare is an appealing area in which to have sector specific exposure in the long run, where appropriate for a client’s risk profile. The use of investment trusts allows investors to pool risk and diversify this exposure, as well as benefit from leverage to enhance returns.

Our research has shown that sectors like biotech and healthcare, Japan equities, Tech media & telecomm are the top performing sectors, whereas forestry & timber and commodities and natural resources are in the worst performing. What would you say the reason for this is?

Biotechnology stocks have benefited from unprecedented M&A activity, as well as excitement regarding medical science advancements. Whilst undoubtedly there will be long term winners in this sector, it seems as though a ‘herd mentality’ has increasingly stretched valuations, causing concerns over a possible bubble.

Japanese stocks have benefited from extreme quantitative easing undertaken by Shinzo Abe which has boosted asset prices, most significantly in the first few months of 2015.

Commodities have struggled in the last year or so as prices have collapsed. Concerns over the health of the global economy and, in particular, China have accelerated the decline. Whilst it is always dangerous to try to catch a falling knife, a specialist investment trust such as BlackRock Commodities Income currently offers a very high yield of 8.85% plus recovery potential after a fall from peak to trough of over 50%.

What are the big challenges that the investment trust sector faces?

Investment trusts seem to be becoming more innovative in terms of fee structure post RDR, which might put pressure on more established investment companies to do the same. For example, Woodford paying a performance fee in the form of new shares on any return over 10%pa, rather than an annual management charge. In addition, other popular strongly performing trusts such as Scottish Mortgage have competitive annual fees of under 0.5%.

Other challenges facing investment trusts are the management of discounts – many companies have been undertaking buybacks in order to close the size of the discount on the fund. In addition, as more and more investment trusts enter the market, competition is increasing, so companies will be faced with a harder task of becoming well-known. Investment trust boards are under increasing pressure from more active shareholders to reform, as seen in the case of Alliance Trust earlier this year.

Please note, this article is for information only and does not constitute investment or tax advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise; pension rules and tax legislation are subject to change; we do not give tax advice. If you would like investment or pension advice on your individual circumstances, please do not hesitate to get in touch on 01392 875500 or info@SeabrookClark.co.uk