Investment trusts are bouncing back
After two torrid years, these funds are rebounding from a nasty downturn, says Max King. Don’t miss out
The past two years have been a struggle for investment trusts. Yet since Foreign & Colonial was established in 1868, trusts have had many ups and downs. Each time the sector has responded with rationalisation, improved governance and innovation, and the subsequent recovery has more than made up lost ground. Is it really different this time?
At the end of 2021, the sector was riding the crest of a wave. The FTSE Equity Investment Instruments had, in 2020, outperformed both the All Share index and the MSCI World index by record amounts. By the end of 2021, the sector’s assets had hit an all-time high of £277bn, fundraising from existing companies was running at record levels (£11bn in 2021), there had been 16 new issues raising a further £3.8bn and discounts to net asset value (NAV) at which shares traded had, on average, fallen to negligible levels.
In contrast 2023 saw discounts for the sector, excluding 3i, reach nearly 18%. There were only two new issues, raising less than £50m, and only £1.1bn of new money raised by existing companies. The sector had returned 4.9%, much better than the -16.6% of 2022, but this still lagged the All Share index and the MSCI World index. Share buybacks reached a record £3.6bn, four mergers were completed (with four more in process) and eight funds liquidated.
Since then, discounts have narrowed to 15.3%. Some subsectors are flourishing, notably technology and North America, but others, notably renewable energy, are deep in the doldrums. “Recent times have been challenging,” says Richard Stone, CEO of the Association of Investment Companies, “but the sector still has 360 companies with £270bn of assets and paid out £7bn of dividends last year.”
He points to several difficulties. The rise in interest rates and bond yields has undermined the market, especially yield-based alternative funds, while an uncertain macroeconomic backdrop has dented confidence, too. Fund outflows from open-ended funds, including trackers and multi-asset funds, has made them forced and indiscriminate sellers. Misguided regulation and misleading cost disclosures have made it difficult for wealth managers and financial advisers to invest more in trusts. Finally, some recently launched investment companies have hit the headlines for the wrong reasons.
Grabbing the bull by the horns
Widening discounts have compounded poor underlying performance. Investors have become sceptical of the asset values of all funds investing in private equity, infrastructure and property. Old investors are disillusioned and new investors are wary.
Investment trusts have responded more decisively than in previous downturns. Shares have been bought back at discounts, enhancing NAVs, often financed by asset sales. Directors have been willing to merge their trusts with others or to liquidate, removing a growing number of sub-scale, underperforming funds.
There have been nine switches of management company, the most since 2009, while 26 trusts have cut their fees. Most importantly, investment
“Investment companies, which date back to Foreign & Colonial in 1868, are a great British success story”
performance is improving and discounts are narrowing. There are few funds whose share prices are still falling. This ought to make investors more confident and encourage buyers, but it’s a case of once bitten, twice shy for many.
Stone is positive about the future. Though “capital raising looks challenging”, that will limit the supply of new shares while buybacks will continue to reduce the availability of issued shares. Consolidation and liquidation has weeded out some lame ducks and improved the scale and liquidity of the average trust. A sustained fightback against adverse and misleading regulation, led by Baroness Altmann and Baroness Bowles and supported by the AIC, promises an improvement after a decade of relentless deterioration.
Inevitably, investors who have recovered their nerve will be attracted by improving investment performance, the attractive valuation of most markets and assets, and wide discounts to NAV, which have the potential to compound returns as they narrow.
As Stone points out, the need to save and invest for retirement hasn’t gone away. It is greater than ever. The need to fund infrastructure with private capital is pressing; the government has neither the financial resources nor the skill set to do it itself. The investment company structure provides the perfect way to provide a bridge between private markets and public capital.
“Investment companies are a great British success story,” he says. “Our job as the trade association is to press for the most supportive regulatory environment possible, to promote the sector to the widest audience and to engage with investors, the wider financial community, the Treasury, regulators and other relevant parties.
“Current markets are challenging, but the macro factors will turn and hopefully some of the other headwinds will be resolved. We must all be well positioned when they do. Trusts must continue to deliver... over the last five years, investment companies have outperformed their open-ended equivalents in ten of the 15 sectors the AIC maintains.”
The biggest risk for investors may be regret at missing out. The two leading technology investment trusts, Allianz and Polar Capital, are trading at all-time highs, having risen 50% since last autumn. Others may follow.