The idea of patient long term capital is attractive – especially in the context of investment trusts. Higher long term returns could come from the higher risks involved in holding investment trusts. What’s more I think that it could have legs in the adviser community, for themselves – and for at least some of their clients. This thought occurred to me while subbing Platforum’s insightful new report on UK Fund Distribution: Investment Trusts, which covers these investments in the adviser market.
Apart from a few enthusiasts, investment trusts have not succeeded in penetrating the adviser market. And it is easy to see why, as the report makes clear. Mutual funds need a fair bit of explanation to clients – closed-ended investment trusts with their gearing and discounts or premiums need a whole lot more.
And of course investment trusts look rather more risky than their equivalent mutual funds. Again that’s also mostly down to the closed-ended structure and their gearing. (i.e. debt or leverage, if you insist). But one of the areas where some investment trusts score well is in their higher yields – especially when at a discount to NAV. And that’s a powerful lure for retirees in drawdown looking for that illusive extra yield.
Most advisers criticise investment trusts for their illiquidity. To be pedantic for a moment, the problem is more to do with the price at which you can sell an investment trust at certain times than strict liquidity as such. You can almost always sell these investment trust shares in the market – but you may not like the price that you are offered. Markets for them can be thin. On the other hand, there have been a few times when you cannot cash in a mutual fund at all.
The most recent example was perhaps the situation that investors discovered when they could not access their property mutual funds but they could sell their REITs. Further back in time, in the great crash of October 1987, investment trust holders could sell in the panic, but many unit trust holders didn’t have the option and couldn’t cash in their units on Black Monday.
Their short term volatility, and so effective illiquidity, means that investment trusts can present serious difficulties for DFMs who run model portfolios that have to be rebalanced on a fairly mechanical basis. And there are various other difficulties too, although the report points out how these are being mitigated by some of the platforms and suggests some further changes.
But suppose an adviser has some clients who quite like the idea of patient money. The ability to cash in their investments at any time is not something that they need – at least not for some of their money. They can afford to take a view lasting over several decades with some degree of equanimity. In return for taking on what is effectively liquidity risk, the investor might reasonably expect higher long term investment growth. The long term performance of many investment trusts has borne out this risk/return equation.
So a portfolio of investment trusts for some of their money would make sense for a minority of clients who were clever enough to see this and can afford to take a long term view.
But just as this approach isn’t for every client, it also isn’t going to appeal to every adviser (although there is, of course, a regulatory obligation for them to consider the full spectrum of investment types). Investment trust providers who want to identify the sorts of financial adviser to whom they should be talking, could do worse than read UK Fund Distribution: Investment Trusts.