Small funds should beware a deluge
As IFAs show signs of warming to the appeal of closed-ended funds, experts sound a warning that some trusts might find themselves unable to cope with a flood of inflows in a rising market.
Investment trust brokers have been keen in recent months to demonstrate how, over a series of timeframes, closed-ended funds have outperformed their open-ended equivalents.
So far this year, Collins Stewart and Winterflood Investment Trusts (Wins) have produced tables highlighting both short-term and long-term performance of investment trusts as the sector looks to get into the limelight ahead of the approaching retail distribution review (RDR).
However, one leading IFA questions whether the investment trust community has fully thought through the implications of its funds becoming mass market vehicles.
Mark Dampier, the head of research at Hargreaves Landown, who admits he is a fan of investment trusts, says that for many trusts a swathe of new money invested in them based on performance could “ruin them”. (Investment trusts continues below)
“Investment trusts are fine as niche for private investors, but not as mass market vehicles,” he says. “The reason for this is their lack of liquidity. Most trusts are very small. While you can buy a few pounds of one, how will it cope when a platform puts all the deals together resulting in much larger inflows?”
For example, he says trusts can cope when a small IFA wants to invest about £5,000, but a platform wanting to do a deal of say £20m will present larger problems.
“It might take days or weeks to complete a buy/sell if the market is moving up, and if you can’t complete, investors will want compensation,” says Dampier.
Another problem he highlights is that in periods of excessive demand even the larger trusts will permanently trade at a premium to net asset value (NAV).
“Trusts only have so many shares in issue,” he says. “They simply cannot satisfy all the demand, which is why they were never meant to be mass market vehicles. I am not sure the investment trust industry has fully through this through.
“IFAs are often accused of not buying investment trusts because of their lack of commission. This is a small part of the problem, but my main concern is how can they cope with the mass market?”
Andrew Watkins, a sales director of specialist funds at Invesco Perpetual, agrees. “I think it very unlikely that the world is going to change dramatically in favour of investment trusts postJanuary,” he says. “Both the large and the small trusts should have worked out a strategy for issuing and buying back shares should premiums race away or vice versa.
“Otherwise – again Mark is right – if periods of excess demand push prices to abnormal premium levels, new investors will be rightly disconcerted when the premium suddenly disappears and is replaced by a discount when supply exceeds demand - and this will happen sometimes.”
As for liquidity, in Watkins’s view the principal beneficiaries of RDR will be the most liquid, best-performing trusts that will not give investors problems to buy and sell. “So, obvious beneficiaries in our stable would be Edinburgh (which has circa £1.1 billion of net assets) and Perpetual Income & Growth (circa £650m); from other houses, Murray International, Templeton Emerging Markets, Scottish Mortgage etc,” he adds.
”Trusts only have so many shares in issue. They simply cannot satisfy all the demand”
“Platforms will respond to demand from advisers for investment trusts to be included. With only a few exceptions (perhaps the likes of Gervais Williams’s Diverse Income Trust, for example, and Personal Assets), the majority will be in the large, liquid, best-performing category, across all sectors.”
Kieran Drake, a research analyst at Wins, says that while performance comparisons between the closed and open-ended funds is an important factor, there are a host of other aspects for investors to consider when looking at investment trusts.
“Liquidity can be an issue, but it is very much dependent on the individual trust,” says Drake. “Our view is those trusts that will potentially benefit most from RDR will be the larger vehicles with better liquidity and strong performance records.”
He adds that trusts can also issue new shares on a rolling basis to cope with rising demand, as well as conducting larger bulk issues, including C-share issues. “Unlike open-ended funds, investment trusts don’t have the ability to simply create and destroy units on demand. The process is more complicated as existing shareholder approval is required to issue new shares.”
David Barron, the head of investment trusts at JP Morgan Asset Management, notes the argument that simply issuing new shares to match demand is akin to turning trusts into quasi open-ended funds and destroying their closed-ended benefits. “I would counter this by saying that firstly it is the board of the investment trust which sets the terms on which the new shares are issued,” says Barron. “This means they can protect their existing shareholders and preserve the characteristic of the trust.
“Second, take a look at the performance of the trusts which are regularly issuing new shares. In our stable the JPM Global Emerging Markets Income has grown its number of shares in issue by about 65% since launch in July 2010 and yet has managed to maintain its outperformance of its benchmark.”
Barron and Drake note how the use of discount control mechanisms and buying back stock, can prevent the discount to NAV widening too much. “Yes, several trusts are illiquid, making the ability to deal large orders a potential problem, but it is worth noting that some large wealthy management firms, running sizeable amounts of money, do use investment trusts to significant effect,” says Barron.
Despite this, neither Barron nor Drake expects a flood of new money through the doors on January 1, 2013, as RDR comes into force.
“As we don’t think there will be a huge inflow of assets on January 1, it means there will be time for adjustments to be made as investment trusts feel their way through,” says Drake. “Just one of the three major fund platforms, Fidelity’s FundsNetwork, has said they will offer access to [investment trusts] ahead of RDR, so there won’t be accessibility straight away.”
While Barron predicts a rise in demand for investment trusts after RDR, he cannot forecast how heavy it will be. “There is genuinely more interest from IFAs, and this will lead to more demand,” he says. “Investment trust groups are at different stages of development in their ideas for what to do, but this is an opportunity that should be taken seriously.”
Barron also argues this is different to saying trusts are mass-market vehicles. He says just as there are a large spectrum of funds on offer, so is there a large spectrum of advisers to whom some trusts are more suitable to some than others.
“It is a complex demand environment,” he concludes.