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The Financial Times
With a worldwide network of highly respected journalists, The Financial Times provides global business news, insightful opinion and expert analysis of business, finance and politics. With over 500 journalists reporting from 50 countries
The Financial Times Guide to Investment Trusts
Unlocking the City’s best kept secret
Second edition
John Baron
PEARSON EDUCATION LIMITED
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United Kingdom
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Web: www pearson com/uk
First published 2013 (print and electronic)
Second edition published 2020 (print and electronic)
The right of John Baron to be identified as author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988.
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Print edition typeset in Stone Serif ITC Pro 9.5/14 by SPi Global Printed by Ashford Colour Press Ltd, Gosport
NOTE THAT ANY PAGE CROSS REFERENCES REFER TO THE PRINT EDITION
To Thalia, Poppy and Leone, with my love
And to those who have helped me, with my thanks
Contents
About the author
Author’s acknowledgements
Publisher’s acknowledgements
Foreword
Introduction: The evolving landscape of investment (trusts)
1 What are investment trusts?
Structure and gearing
Value and calculations
Discounts and premiums
Price and size
Range and reach
Governance and cost
Pros and cons
2 Better performance
The evidence
Undertaking research
Performance nuances
Maintaining perspective
Beware unit trust tables . . . . . . and ‘sister’ funds
3 Competitive fees
Time and numbers
International comparisons
Other factors encouraging competition
Ongoing Charges calculation
Performance fees
4 Structural advantages
Merits of a closed-ended structure
Poor selling decisions
Yield and diversification
Liquidity and volatility
Less mainstream assets
5 Geared tailwinds
Mathematical logic
The logic in practice
The issue of sentiment
Understanding ‘splits’
6 Discount opportunities
Factors influencing discount levels
Profiting from discount movements
Discount control measures
Z-statistics
7 Dividend heroes
The mechanics
Revenue reserve
Dividend heroes
Capital changes
Dividend terminology
Dividend metrics
Tighter discounts
8 Independent board
An evolving role
Greater professionalism
Common interests
Monitoring holdings
Social accountability
Report and accounts
Regular communications
Marketing and distribution
Investment roadshows and seminars
The AIC
10 Comparing investment trusts
The various factors
Outlook and balance
Manager and team
Long-serving managers
Valuations
Debt matters
Fee comparisons
Income considerations
Structure and discount control mechanisms
Financial Express and Morningstar
The golden rule
11 Perspectives – three fund managers
Nick Train
Neil Hermon
Charles Jillings
12 Perspectives – the AIC and a board director
Annabel Brodie-Smith
Jonathan Davis
13 Perspectives – an analyst, a shareholder and an editor
Alan Brierley
Lord John Lee of Trafford DLFCA
John Hughman
14 Deciding investment objectives
Saving and investing
Know thyself – risk tolerances
Income requirements
Currency considerations
Choosing a benchmark
15 Accessing markets
Retail Distribution Review (RDR)
Platform providers
Robo-advisers and exchange-traded funds
Wealth managers
Do-it-yourself
16 First principles
First steps
Time in the market
Reinvest the dividends
Diversify to reduce portfolio risk
Rebalancing
Reaching investment goals
17 More considerations
Be prepared to be a contrarian
Keep it simple (and cheap)
Be sceptical of ‘expert’ forecasts
Embrace Einstein’s eighth wonder
18 Further considerations
Active versus passive
Portfolio turnover and conviction
Different investment styles
Marketability
An inconvenient truth
19 The Summer portfolio
Context
Breakdown
Equities
Thematic investments
Other asset classes
A holistic approach
A golden rule
20 Recent commentaries
Where are our pioneering giants?
Do not sell in May
Retaining faith in technology
Patience is usually a virtue
Keep calm and carry on
Index
About the author
John Baron is best known to readers of the FT’s Investors Chronicle magazine for having successfully managed and reported on two real investment trust portfolios since 2009 – as measured by their appropriate MSCI PIMFA Growth and Income benchmarks. His popular monthly column is closely followed and helps investors – private and professional – with their investments.
John has used investment trusts in both a private and professional capacity for over 35 years. After university and the Army, in a career spanning 14 years, he ran a broad range of charity and private client portfolios as a director of both Henderson Private Clients and then Rothschild Asset Management (RAM). Whilst at RAM, he was also responsible for the core UK equity portfolio.
Since leaving the City, John has helped charities monitor their fund managers, contributes to other publications including The Investment Trusts Handbook 2020, and regularly speaks at investment seminars. He remains a member of the Chartered Institute for Securities & Investment.
He has also founded Equi Ltd which manages the website www.johnbaronportfolios.co.uk. The website reports in real time to members on the progress of nine real investment trust portfolios as they achieve a range of risk-adjusted strategies and income levels. The website’s Performance page testifies to their success relative to benchmarks.
His central message is that investment trusts are the best form of funds for most long-term investors if properly harnessed, and that investment is best kept simple to succeed – complexity adds cost, risks confusion and usually hinders performance. This philosophy runs through this revealing book about the City’s best-kept secret.
Author’s acknowledgements
The writing of any book is a real team effort. This book draws on the expertise and talents of many people. My thanks go to all who have made valuable suggestions, contributed to its compilation and helped with its production.
In no particular order, I would particularly like to thank:
The team at the Association of Investment Companies (AIC): David Michael (my first point of contact) and Sophie Driscoll for their expertise and guidance, Annabel Brodie-Smith for her valued input, and Ian Sayers for his contribution and wise oversight of such a great team;
The book’s contributors in Chapters 11, 12 and 13 for their perspective and sage advice: Nick Train, Neil Hermon, Charles Jillings, Annabel BrodieSmith, Jonathan Davis, Alan Brierley, Lord John Lee of Trafford DL FCA and John Hughman;
The editorial team at Pearson Education for their patience and professionalism: Dr. Priyadharshini Dhanagopal in India, Eloise Cook, Melanie Carter and Felicity Baines in Harlow, and Suzanne Pattinson in Cambridge;
And last but certainly not least, the team at home: My wife Thalia and daughters Poppy and Leone for their inspiration and help with technology!
at Blackrock. Used with permission from BlackRock, Inc; 266 John Baron: Baron, J. (2019, February 7). Where are our pioneering giants? Used with permission from John Baron; 269 John Baron: Baron, J. (2019, May 9). Do not sell in May. Used with permission from John Baron; 272 John Baron: Baron, J. (2019, August 8). Retaining faith in technology. Used with permission from John Baron; 275 John Baron: Baron, J. (2019, October 10). Patience is usually a virtue. Used with permission from John Baron.
Foreword
In many respects, investment trusts remain the City’s best-kept secret. Despite evidence confirming they perform better and are cheaper than the unit trusts and open-ended investment companies (OEICs) which dominate the nation’s investment and savings market, too many investors continue to be unaware of them or think them too complex.
This is slowly changing. The introduction of the Retail Distribution Review (RDR) in 2013 and other changes to financial regulation are proving to be catalysts. Others include a far greater awareness of the many advantages of investment trusts courtesy of the financial media and professional organisations, including the Association of Investment Companies (AIC). Investment trusts are emerging from the shadows although there is still some way to go before they enter the investment ‘mainstream’.
At a time when there is sadly a growing financial ‘advice gap’ and the cost of advice is rising, investors would benefit from better harnessing their potential. This further edition of The Financial Times Guide to Investment Trusts will help investors better understand investment trusts and how they can be best harnessed to achieve financial objectives. Characteristics such as their structure, gearing and discounts are explained, as are their more nuanced characteristics which all help to determine how trusts perform and are perceived.
The book also highlights the stepping stones to successful investing, the principles of sound portfolio management, and how to construct and monitor a trust portfolio. We at Equi believe such knowledge is not only important but necessary. For the evidence suggests better investing can help to reduce inequalities within society. Why else do the rich keep getting richer? We are on a mission to both inform and help investors achieve better returns.
The final section of this guide will feature how we put theory into practice, for actions speak louder than words. By way of illustration, the thinking and strategy behind one of the nine real investment trust portfolios being managed in real time on my company’s website will be explained in some detail, together with the various factors we consider when selecting holdings.
If ever there was any doubt, knowledge continues to be the bedrock of successful investing. This book aims to explain the potential of investment trusts in a clear, concise and jargon-free manner. It shows their apparent complexity is a myth – a myth which has tended to obscure the many merits of investment trusts for too long. It is hoped readers will benefit from a better understanding of the wonderful opportunities on offer.
Introduction: The evolving landscape of investment (trusts)
The investment (trust) landscape has continued to evolve at a clip since this book was first published in 2013. Some aspects have changed for the better, some not, and some are progressing albeit perhaps a little too gradually. As with most things in the financial world, it’s a curate’s egg. The challenge is to focus on those parts where improvements can be best made for the benefit of investors.
What is undeniable is that those investors looking at investment trusts to help them achieve financial goals are today fortunate in that the sector is now at one of its pinnacles when viewed against its proud 150-year history. Investment trusts are better poised than ever to play an even greater role in helping informed investors achieve their financial goals.
The good
However, it remains a truism that too little is generally known about investment trusts – they have yet to enter the investment ‘mainstream’. Why is this the case? After all, they have been around for a very long time. Many can trace their ancestry back to the nineteenth century. And over this period, they have proved themselves not only to be perhaps the greatest innovation for long-term investors, but also the most rewarding.
Some of them are very large with market capitalisations exceeding £8,000 million, whilst assets under management within the sector total around £200 billion. These are significant numbers. The largest, Scottish Mortgage Trust (SMT), is now a constituent of the FTSE 100 index. Sections of the financial press often talk about the merits of investment trusts, including their better performance and cheaper fees when compared with the unit trusts that dominate the retail market.
And yet, the typical investor is unaware or cautious of them. It is one reason why, with the open-ended market valued recently by the Investment
Association (IA) at around £1.24 trillion, the investment trust sector is onesixth the size of open-ended funds (typically unit trusts and open-ended investment companies), despite their longer history and superior performance. So why is it so few investors outside the wealth managers in the City and Edinburgh benefit from them? The answers are various.
Fewer hurdles
A common thread linking them has been a competitive landscape which was tilted against investment trusts. This is now slowly changing. The key catalyst has been new regulations introduced in 2013. Hitherto, many investors had used an independent financial adviser (IFA) to help them run their portfolios. Most of these professionals earned their money not by charging the client a fee, but rather by receiving commission payments from the managers of the products they sold to the client.
Investment trusts do not pay commission to IFAs. Open-ended funds such as unit trusts did. As a result, there has been an in-built bias in favour of the latter. Some clients may have thought they were getting ‘free’ advice as they did not directly pay the fee. Most clients would have been aware of the arrangement but perhaps hazy about the scale of commission paid to their IFAs.
Much of this changed in January 2013 when new rules were introduced as a result of the Retail Distribution Review (RDR). These rules banned commissions. Instead, IFAs are expected to earn their fees by charging the client directly themselves and up front. The fee may be an hourly charge depending on the time spent or a fixed fee depending on the type of advice. Whichever, the effect will be the same – fees will be paid directly by the client.
One objective of the RDR is to make charges much more transparent. Another is to eliminate potential conflict of interest claims against IFAs regardless of how well they have served their clients. The jury is still out. But whether a success or not, investment trusts will benefit. These trusts are now competing with their open-ended cousins on a more level playing field. And, although it is early days, there are encouraging indications that investors are benefitting as a result.
Better awareness
However, this is only part of the story. Investment trusts have not always been good at setting out their stall. They are a slightly more complex instrument when compared with open-ended funds. And sometimes this complexity has been exaggerated. Yet historically there have been few marketing campaigns to put this right. Compare this to the massive marketing by the unit trust industry, especially when the new ISA season approaches.
This failure to reach out to investors has not been helped by the odd bit of bad publicity. Some investors will remember the split capital investment trust scandal. During the late 1990s, these trusts were marketed as low-risk investments, particularly for those seeking income. But high gearing and intricate cross-holdings made for a volatile mix. The detail is unimportant, but a number of investors lost out after the market crashed in 2001–2.
Though severe for those involved, the bad publicity was out of all proportion to the scale of the affair. Only a few fund managers were felled by the scandal, but it threw a dark shadow over most of the investment trust industry. The episode seemed to confirm to many that investment trusts were a ‘dark art’ best avoided. It certainly did not help the industry’s profile or appeal to investors.
This environment is now slowly changing for the better. Investors are coming to realise the many advantages of investment trusts. Progress is slow but it is inexorable. There has been more coverage in the financial press highlighting the better performance of investment trusts compared to their open-ended cousins, and often by some margin. The press has also highlighted that investment trusts are a cheaper way of gaining exposure to markets – an issue of increasing importance. These two facts are not unrelated.
There has also been the sterling work of the Association of Investment Companies (AIC), the industry’s well-respected trade body, which has done much in recent years to inform and educate. A visit to its website is well worthwhile. For example, the animated video entitled ‘Your investment journey’, launched in October 2018, explains why and how to go about investing and where investment trusts can fit in.
An evolving industry
The industry itself has continued to evolve. It has emerged from the split capital crash with an endeavour wholly conducive to investors. Part of this has been driven by necessity. The rise of passive low-cost instruments (such as exchange-traded funds and index funds), together with activist investors looking to crystallise undervalued situations, has spawned self-help and innovation.
In responding to investors’ recent search for yield, a host of ‘alternative’ assets, including renewable energy and infrastructure, have been encompassed by investment trusts as evidenced by the extent of fundraising. Whilst such assets are now well-established, other examples including trusts which aim to capitalise on recorded music rights and to provide capital to biotech companies prove innovation is alive and kicking. Once again, such examples are proving helpful to those investors seeking income and diversification.
Following the crash, regulatory and governance changes have also assisted the sector by helping to improve the way trusts are managed and by making it easier for trust boards to market their company, issue new shares and pay higher dividends out of capital, all of which benefit shareholders to varying degrees.
In doing so, more investors are coming to appreciate trusts’ other helpful features. These include the ability to ‘store’ dividends and so produce a growing stream of income even when markets are rocky – helpful for longterm planning. An increasing awareness that their structure is better suited to certain illiquid asset classes, such as private equity and commercial property, has helped – and funds have been raised accordingly from investors from both established and new investment trusts.
The rise of more conventional equity IPOs (initial public offerings) has also been a welcome feature in recent years. An IPO is the very first sale of stock issued by a company to the public. Examples in 2018 saw Mobius Investment Trust (MMIT), AVI Japan Opportunity Trust (AJOT), Baillie Gifford US Growth Trust (USA) and Smithson Investment Trust (SSON) all be created courtesy of fundraising, the latter raising a record £822 million.
Meanwhile, many well-respected investment trusts are raising their assets under management and continuing to grow by initiating regular secondary share issues courtesy of their share prices standing at premiums to their Net
