How to choose an investment trust?

Russ Mould, AJ Bell Investment Director, runs through a 10 point checklist to consider when researching investment trusts for your portfolio.

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How to pick an investment trust

Most of us will be pretty familiar with the term “fund” when it comes to investing, but there are several different types and they come in many shapes and sizes – and one version that’s often overlooked is the investment trust.

They have certain characteristics which mean they are quite different from open-ended pooled investment funds and today I’d like to explain how you can assess an investment trust and whether it may be suitable for inclusion in your portfolio, once you have done your own research.

Hello, I’m Russ Mould, AJ Bell’s Investment Director, and in the next few minutes I’m going to take you through a 10-point checklist that should help you in your personal study of whether an investment trust is right for you or not. 

So, check number 1 is the mandate of the investment trust.

This means will the trust invest in an asset class that is suitable for you? They can invest across a huge range of options, from shares to bonds to property, from quoted companies to private ones and across a wide range of geographies and industries, from Japan to Latin America to the UK, technology to mining. The choice is yours, but you need to make sure it fits with your personal target returns, time horizon and appetite for risk (and remember by appetite for risk I mean the willingness and ability to suffer losses in pursuit of gains).

Check number 2 is the style of the investment trust

Some target income, through the steady harvesting of dividends from shares and coupons from bonds. Some target capital growth, by trying to pick securities or assets which will rise in value over time. Some try to provide a mix of both. You will know which style you prefer.

Check number 3 is the identity of the fund provider

You may feel more comfortable buying trusts provided by big fund managers whose names you know and like, who offer a wide range of choice and who provide research tools and clearly-presented investor updates on their websites.

Check number 4 is the performance record of the individual fund manager and the investment trust itself.

Now, we all know the past is no guarantee for the future but in the end you are looking for the investment trust to protect and boost your wealth – so you are bound to check out how the fund manager and the trust have done over time.

Ideally, you should study 5 or 10 years’ of data at least, if the trust has been around that long, and the same goes for the fund manager. You’ll be looking for absolute performance, not just performance relative to a benchmark.

You can also look at third-party research, such as the Morningstar ratings made available on the AJ Bell Youinvest website.

The good news is all of the performance figures and star ratings are available for free from a range of sources, including the fund manager themselves and your broker.

Check number 5 is the cost of owning the investment trust.

Here at AJ Bell Youinvest investment trusts are treated the same as shares so you will pay the same costs for dealing and holding them as you would a stock. 
Additionally there will be an ongoing charge figure (or OCF) each year, taken by the investment trust manager. According to industry body the Association of Investment Companies, in July 2016 the average OCF was 1.18% and 1.34% including performance fees, and the trend in these has been generally down over the years.
It’s easy to compare OCFs (and performance) when looking at investment trusts that target the same asset classes, geographies and industries or different ones via a number of free websites.

Check number 6 is the process followed by the trust and the resource available to its fund managers.

Ideally, you are looking for a well-resourced investment trust with a number of managers working on the portfolio (though not so many that the costs balloon), with good support from in-house research that may give them a performance edge.

In addition, you should try to understand what the fund managers look for and how they work, and the process they use. Do they do lots of company meetings? How long do they hold an investment for on average? What are their preferred valuation tools? Do they hold their securities passively or do they actively engage with management teams? You’ll know what you are looking for here on all of those counts.

Check number 7 now this is where we start to get technical, as you need to look at the discount to net asset value (or N A V). 

Remember that with an investment trust you are buying shares in the portfolio, in the investment company, and the shares can trade at a discount or a premium to the underlying value of the holdings. The shares will just respond to supply and demand, more sellers than buyers or more buyers than sellers.

It’s best to avoid paying a premium if you can, as this effectively gives away some of your future performance and a discount can be nice way of getting in.

Discounts can exist if the investment trust’s sector is out of favour or performance has frankly hit a rocky patch. If sentiment turns, the underlying assets may go up and the discount close, adding to your investment return – equally though the reverse can happen and the discount widen and the underlying fall.

Since 1997 the discount to NAV has averaged around 9% according to the Association of Investment Companies – that figure got down to 3% in 2015 but got been as high as nearly 18% during the Great Financial Crisis and market meltdown of 2008. 

Check number 8 is to look at the investment trust’s dividend policy. Not all of you will be looking for income but those who are may be intrigued to learn that 19 investment trusts have increased their dividend every year for at least 20 years (and 18 more have done so for at least a decade).

Moreover, 43% of Association of Investment Company members pay quarterly dividends, now that’s up from less than a fifth six year ago and five even make monthly payments.

Check number 9 is another technical one, namely to look at the investment trust’s gearing – and you can do this by looking at the factsheet or research that is freely available on websites such as ours.

Investment companies can borrow (“gear up”) to magnify income and capital returns – though it can also have the opposite effect and magnify losses, and only you will know whether you are comfortable with this or not.

As of July 2016 the industry average gearing ratio was 7%, according to the Association of Investment Companies, although there is quite a wide range there.

And last but by no means least check number 10 is to look at the composition of the board.

Remember investment companies are that companies with executives and they are there to monitor performance and also ensure shareholders’ and stakeholders’ interests are aligned – if they think circumstances require it and performance has been sufficiently poor then the board can actually sack the fund manager or change the mandate of the trust.

You should therefore check to make sure the board members have suitable skills and experience for the job. Ideally the board should also own some shares so they have got the same vested interest as you.

So, just to summarise, my suggestions for a 10-point checklist on how to select an investment trust that may be right for your personal needs and investment goals is as follows:

One - Mandate
Two - Style
Three - Fund provider
Four - Performance record
Five - Fees
Six - Process and resource
Seven - Discounts to NAV
Eight - Dividend policy
Nine - Gearing 
Ten - Board Composition

This list is by no means exhaustive, but it is hopefully manageable and a useful pointer when it comes to doing the research you simply have to do before you invest and look for the risk-adjusted returns which best suit your personal investment strategy, goals, time horizon and appetite for risk.

Thank you for watching and I look forward to seeing you next time.