Fund managers running investment trusts have had a stormy year.
With the pandemic buffeting markets, the average discount to asset values — a key performance measure — has widened from a historic low of just 1.3 per cent at the end of 2019, shortly before Covid-19 struck, to around 7 per cent at the end of last month, according to the Association of Investment Companies (AIC), the industry body.
But it could have been much worse — in March, at the height of the market sell-off, the average discount soared to more than 22 per cent, the biggest since the 2008 financial crisis, with individual investment trusts dropping to discounts greater than 30 per cent.
The subsequent recovery has been uneven, a reflection of the range of the 400 or so investment trusts with money in everything from UK shopping centres to Tesla, the electric car company. Trusts are moving towards the end of 2020 with their assets valued at just over £200bn, a little more than the end-2019 total, according to AIC figures.
“In my 29 years, this has probably been the most challenging,” says Job Curtis, longtime manager of one of the UK’s oldest investment trusts, City of London, founded in 1861. Despite the impact of Covid-19, the trust increased its dividend this summer for the 55th consecutive year, but did so by using its reserves to cover 20 per cent of payments — the highest drawdown ever.
The capacity of trusts to maintain or even increase payouts to investors when many listed companies were cutting or axing them has shone a spotlight on the trust business model, and driven a resurgence in popularity with investors.
But dividends are not the only attraction of a financial institution known for its wide diversity and flexibility of purpose.
Flexibility and creativity
Investment trusts were developed in Victorian Britain to help the growing middle classes take advantage of growing, but risky opportunities in far-flung corners of the British empire. By pooling investments, fund managers could limit risk for their clients and make a profit themselves if things went well.
Unlike open-ended mutual funds, investment trusts are closed-ended, so investors can buy and sell shares only by trading with other investors on the stock market. They cannot demand their money back from the fund managers. Equally, their cash cannot be frozen inside a failing fund, as happened last year to open-ended fund investors in Neil Woodford’s flagship Equity Income fund.
This allows investment trust managers to be more daring — in taking on gearing, for example, or focusing on alternative investments. Or to be prudent and build reserves in times of plenty to cover lean years.
Freedom has encouraged creativity. Investment trusts have branched into different directions such as the UK economy, especially smaller companies, rising Asian markets and global infrastructure.
The Covid-19 crisis has highlighted the strengths of investment trusts for investors, such as their ability to provide consistent income, hold unlisted growth stocks and give exposure to alternatives.
Retail investors have been hit hard this year by the marketwide collapse in corporate dividends. UK payouts are likely to have fallen by about 39 per cent for the year, down to just £60.4bn in the best-case scenario, according to analysis from Link Group, an investor services business.
But many investors in trusts have been cushioned from the blow. Some 58 per cent of the 124 trusts that have reported so far this year have increased payouts, according to the AIC, and a further 23 per cent have held them.
More than 19 trusts, singled out by the AIC as “dividend heroes”, have increased their dividends every year for 20 years. Among them is City of London, where Mr Curtis says: “Investment trusts have this structural advantage for income in that they can smooth the experience.”
Acknowledging the challenges involved in steering the company through the pandemic, Mr Curtis adds: “That’s what makes the job endlessly fascinating, the world changes and you have to guide the portfolio through. The sheer number of dividend cuts in the UK has been a pretty tough period. But the fundamental strengths of the structure and core of our portfolio has seen us through it.”
Persistent low interest rates could encourage even more retail investors to go for income-focused investment trusts — especially if Bank of England rates turn negative.
“If people need income, they’re not going to get it from banks,” says James de Sausmarez, head of investment trusts at London-based manager Janus Henderson. As people look to the capital markets instead, “investment trusts have a performance advantage. The fees are good, and the board provides good protection for shareholders.”
The sector’s ‘poster child’
Other trusts have stuck to growth, few with more success than the Scottish Mortgage Investment Trust from the Edinburgh investment manager Baillie Gifford, founded in 1908.
The trust has generated cumulative returns of 674 per cent over the past decade off the back of large, long-term investments in tech stocks like Tesla, beating the FTSE All World index which rose just 191 per cent during that time. The year, the trust is 76 per cent up since March, compared with 24 per cent in the global index.
“2020 is the year of Baillie Gifford,” says Simon Elliott, head of research at Winterflood Investment Trusts. The manager’s flagship trust, Scottish Mortgage, is “the poster child of the investment trusts industry”.
James Anderson, Scottish Mortgage’s manager for over 20 years, bet big on technology more than a decade ago at a time when many investors were still licking their wounds from the dotcom crash.
Mr Elliott says: “Mr Anderson has always said that if and when the next downturn occurs, that Scottish Mortgage would prove to be defensive. This year that’s really come through . . . they’ve been in the right areas of the market.”
Other tech-focused trusts include Polar Capital, up 44 per cent over the past year, and Allianz, which has total returns of 59 per cent, according to the AIC.
Growth-oriented investment trusts are looking beyond Silicon Valley. Last year Baillie Gifford opened its first office outside Scotland, in Shanghai, in a signal of intent. “If you’re not investing in China for growth you’re missing the point,” says Baillie Gifford China fund co-manager Sophie Earnshaw.
Other trusts backing Asia include Schroder’s Asian Total Return, which is up 26 per cent in the past year, and Pacific Horizon Investment trust, which has had a total return of 110 per cent.
If anything, the trend towards Asia is accelerating, as investors look to markets that have weathered the pandemic. “The big trend from October is that investors are turning east,” says Interactive Investor, one of the UK’s largest retail investment platforms. “There are only three investment trusts that are China specialists, and all three appeared in our top 10 last month, which is extraordinary.”
Trusts have long been popular for investing in emerging markets because of their ability to invest in less liquid holdings without fear of rapid redemptions from skittish investors as might hit unit trusts.
That ability puts trusts in a strategic place, managers say, as rapidly growing privately held companies, such as China’s huge Ant Group, show less haste to list, preferring to raise capital from select groups of hungry investors behind closed doors.
A growing divide
With the global switch from public to private markets, some investment trusts are focusing more on alternative assets, in contrast to the traditional focus on public markets. They offer retail investors a way into these alternatives without the large minimum investments required for direct investments in, for example, private equity.
“One thing to remember about the investment trust sector, is that it’s become two sectors,” says de Sausmarez at Janus Henderson. “Traditional investment trusts, and alternatives.”
In 2020’s volatile markets, established trusts proved a haven for many. “In uncertain times, investors have flocked to . . . those large, global generalists that have been serving investors for decades and decades, through world wars, booms and bust, pandemics and the great depression,” says Interactive Investor. “That is certainly what happened in March this year when we went into lockdown.”
Some alternative funds have suffered badly in tough conditions. For example, the DP Aircraft 1 trust, which invests in leasing and selling aeroplanes, a difficult business during the pandemic, trades at a 94 per cent discount.
But others have prospered. Supermarket Income Real Estate investment trust (Reit) investing in supermarket real estate, has outperformed in the pandemic. And the Warehouse Reit has been an extraordinary bet, cashing in on demand for warehouses to facilitate ecommerce, boosted by nationwide lockdowns. Total return is up 22 per cent over the past three years, and the trust trades at a 7 per cent premium.
“It costs double to build a new warehouse than to buy one already built,” says Monica Tepes, investment company research director at FinnCapp, a broking house. “So the trusts market is split between winners and losers. Some trusts were in the right sectors that were not affected by Covid-19, or benefited from it. Others were hard hit — like property funds that invest in restaurants or cinemas.”
New investment trusts are pursuing new trends. Hipgnosis, an investment trust, invests exclusively in music catalogues from songwriters, making returns on residuals for those songs.
In September, The Home real estate investment trust announced plans to launch and invest in housing for the homeless and capitalise on the desire for ESG investment opportunities.
But managers also have an eye open for unfashionable sectors that might return to the limelight. Recently, three trusts — the Schroder Business Opportunities Trust, Tellworth British Recovery & Growth and Sanford DeLand UK Buffettology Smaller Companies Trust — have attempted to raise capital to invest in UK small companies and apply “value” style investing. However, the going was tough — Tellworth and Buffetology both dropped their flotation plans.
“The UK microcap market looks very cheap right now, but just because something is very cheap doesn’t mean that people will want to buy it and that’s a problem,” says Mr de Sausmarez. “If you like small companies, there are trusts already in the market that are sitting on large discounts.”
The small size of many trusts makes institutions wary: they say the large stake they would need in each trust would make their exposure too great. Some 40 per cent of UK trusts have assets of less than £100m, according to London Stock Exchange figures. Only two trusts have a market capitalisation above £10bn — Scottish Mortgage on £14.8bn and 3i Group on £10.2bn.
The industry has been hit by consolidation, as struggling, smaller trusts are rolled into larger ones, something analysts say is likely to continue. Fifteen trusts have announced their intentions to close or merge since August — compared with five over the same period last year.
“More funds are looking to wind down, taking over other trusts, changing what they do or how they do it,” says Ms Tepes. “This normally happens after you see a crisis.”
But that does not detract from the sector’s popularity with retail investors, especially as deregulation in recent years has allowed more people to take control of their finances, notably in pension schemes. Also, the growth of investment platforms has eased investment processes for savers without access to personal wealth managers. Mr de Sausmarez says: “The reliability of investment trusts is a very attractive thing . . . to the self-advised investor.”
Profile 1: Baillie Gifford China Growth
Co-manager: Sophie Earnshaw (with Roderick Snell)
The investment approach: BG China Growth focuses on listed and unlisted growth stocks domiciled in China, aiming to hold them for at least five to 10 years.
Key points: Baillie’s decision to open a research office in China, its first outside of Scotland in 110 years, “speaks to the importance of China for the firm,” Ms Earnshaw says, pointing to China’s “sheer size and the hunger for the new, and willingness to adopt tech and innovation”.
The ability to invest in unlisted shares has been a boon to the trust.
It argues that UK investors are underexposed to China — which has represented one-third of global economic growth in the past decade. The fund prides itself on building close relationships with selected companies and on looking outside China’s biggest cities for opportunities.
Ms Earnshaw says many companies it holds stakes in had never been contacted by international investors before. “China is so exciting because of sheer scale,” says Ms Earnshaw, who has steered the trust into large holdings in healthcare, electric vehicles and domestic Chinese clothing brands that are expected to grow as China turns away from the West. “You’re starting to see an ecosystem of innovative companies really emerging like what you have in the West Coast of America. It’s something that we’re thinking about a lot,” says Ms Earnshaw. The trust trades at a 31.5 per cent premium to its net asset value.
Profile 2: Hipgnosis
Manager: Merck Mercuriadis
The investment approach: Hipgnosis invests in music catalogues by songwriters — and makes money on residual payments from users.
Key points: Hipgnosis has turned music into an asset class and is poised to cash in on the extension of a song’s life by streaming platforms. It has paid more than £1.3bn since 2018 to song writers in exchange for partial or total rights to components of their streaming catalogues. It operates in some ways like the back office of a record label, profiting from the public’s sustained appetite for content. “Songs are better than gold and oil because if Trump does something stupid tomorrow, gold will be affected, oil will be affected, but music won’t. People are going to always enjoy music,” says Mr Mercuriadis, a slick salesman who came up through the music management industry.
The fund has acquired more than 50,000 songs across catalogues from Barry Manilow, Blondie, Wu-Tang Clan, Motley Cru, and a songwriter for Lady Gaga and RedOne, among others. The fund’s emphasis on songwriters reflects fundamental changes in the industry — fewer performing artists are writing their own songs, relying instead on songwriters. The fund also says it pushes songs back into relevance through placements in movies or getting them covered by younger artists. Record companies invest in artists, in the hopes that they score a few hits. Mr Mercuriadis says: “I’m just buying the hits.”
Profile 3: City of London
Manager: Job Curtis
The investment approach: A fund that invests heavily in established, dividend-paying companies, mostly in the UK, for income.
Key points: One of the UK’s longest running trusts (originally a brewery), City of London is known for its dividend, which it has increased every year since 1966. The portfolio is defensively positioned, Mr Curtis says, increasing holdings in consumer staples this year, while reducing exposure to travel and leisure and other sectors where it will probably take some time for dividends to recover.
The portfolio has largely held on to banks, which it believes remain strong and likely to resume dividends. City of London has fallen behind the main market indices in the past five years as growth stocks have outperformed value companies. But the trust says its collective approach remains a safe bet for income-hungry investors wary of holding individual companies — even top stocks — for dividends. Mr Curtis says: “There’s no such thing as a blue-chip any more.”
This article has been republished to amend the Baillie Gifford profile
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