Over the years advisers have frequently cited their lack of familiarity with some of the features of investment trusts as a reason for not using them in clients’ portfolios.
Compared to open-ended funds, investment trusts can seem a little more complex, with their ability to use gearing.
Concepts such as net asset value (NAV) and discounts sometimes alienate advisers but there are now plenty of resources available, explaining some of the jargon around investment trusts and helping them understand where they might fit into a wider investment portfolio.
“Investment companies have a number of features unique to the closed-ended structure. These include gearing, NAV and discounts/premium, to name a few,” points out Annabel Brodie-Smith, communications director at the Association of Investment Companies (AIC).
The AIC has been making inroads by going out to advisers with their roadshows, headed up by Nick Britton, head of training at the association.
Education, education, education
It does appear as if the industry is tackling directly the lack of knowledge among many advisers.
James Burns, partner at Smith & Williamson, says it has been an education process on the part of the fund houses and the AIC.
Tony Yousefian, FundCalibre’s investment trust expert, points out they have created their own guides to discounts, premiums, revenue reserves and gearing. These guides are available on the website and all aimed at the retail investor. They have also created some video content.
The prevalence of jargon can be off-putting but there are often simple explanations for the more technical sounding aspects of closed-ended funds.
Ms Brodie-Smith starts by explaining gearing – a feature unique to investment trusts and one which advisers will need to understand before investing.
“At its simplest, gearing means borrowing money to buy assets and works by magnifying the performance of both income and capital returns,” she says.
As gearing has contributed to the strong performance of investment companies over the long-term as markets have risen, she acknowledges it is important to understand how it works.
“The idea is that the additional investments make enough money to meet the costs of the borrowing and make a profit on top. If the performance of a company with gearing is strong, the gearing boosts the company’s performance.”
Ms Brodie-Smith cautions: “However, the reverse is true and if the performance of a company with gearing is weak, gearing will be a drag on the performance. Not all investment companies use gearing, with just over half not using gearing and those that do use gearing use relatively low levels.”
Figure 1: How gearing affects performance
Source: AIC
She suggests should advisers and investors want a clearer understanding of how geared an investment company is, the AIC publishes the current level of gearing of member companies on its website and the gearing range – “the maximum and minimum levels the company would expect to be geared in normal market conditions”.
