Investment Trusts in a post-RDR world
I have had several conversations this week on the subject of Investment Trusts and how these will benefit from the implementation of the Retail Distribution Review next year.
Investment Trusts are a type of collective investment fund, where investor money is pooled and then invested by a professional fund manager. They have a closed-ended structure, which means they have a limited number of shares.
In this sense, they differ from open-ended collective investment funds, such as Unit Trusts and Open Ended Investment Companies (OEICs).
Independent Financial Advisers (IFAs) have been accused historically of failing to recommend Investment Trusts. The main reason supporting this accusation is that Investment Trusts do not pay commission whilst other forms of collective investment funds do.
When the Retail Distribution Review comes into force on 1st January 2013, commission will no longer be a part of the equation for any financial adviser. With this in mind, the Investment Trust industry is hoping the new level-playing field will see sales of their products soar.
This is unlikely to be the case.
As a firm of Chartered Financial Planners who have not operated on a commission basis for nearly seven years, there are other important reasons why Investment Trusts tend not to form a part of our recommendations.
The first reason is gearing.
This is a distinguishing feature of Investment Trusts which typically borrow money to ‘leverage’ or ‘gear’ their returns. In doing so, they are able to invest more money and aim to get a higher return from investment assets than the cost of borrowing the money.
Gearing increases the level of risk to the investor. When markets are going up, gearing can be beneficial. However, when markets are falling or the returns are lower than the cost of borrowing, the losses can be magnified.
The second reason is the discount and premium pricing structure of closed-end funds.
Because Investment Trusts are traded on a stock exchange, rather than investors dealing directly with the fund manager to buy or sell units, the price of the closed-end fund can differ from the net asset value of the fund.
This means that the share price can trade at a premium (when demand for an Investment Trust is high) or at a discount (when demand is low). The share price can swing between premium and discount, often with little to explain these movements other than unpredictable market sentiment.
The third and final reason for the apparent unpopularity of Investment Trusts amongst IFAs is their general lack of availability within suitable tax wrappers and on investment platforms.
It has been very difficult to access Investment Trusts historically, without using a specialist stockbroking platform.
Insurance company product providers, where investors have usually invested their pension and other assets, do not offer access to closed-end funds. Where they do, it tends to come at an additional cost for the trading functionality, for example within a Self Invested Personal Pension (SIPP).
This final point on lack of access has improved in recent years. Modern investment platforms, which are being increasingly adopted as the implementation method of choice by RDR-ready financial advisers, tend to offer access to the entire universe of investment options – including company shares and Investment Trusts.
The debate on the reasons why Investment Trusts remain out of favour with IFAs, and whether this situation will improve at the end of next year, is likely to continue for some time. Hopefully the reasons described above will go some way to explain why the Investment Trust debate is not all about commission.