Are investment trusts old news? Well, they’ve been with us since 1868 and predate unit trusts and open-ended investment companies by decades. But there are very good reasons why their tried and tested structure is still with us – and why it’s still going strong. 
One of the main advantages of investment trusts is that they promote a long-term approach. That’s because their closed-ended structure allows their shares to be traded on the stock exchange without requiring any action on the part of the trust itself. Accordingly, the manager can focus entirely on the portfolio’s holdings, instead of having to worry about redemptions, liquidity and lock-ups.
This is crucial, because it means that investment trust managers can stick with their long-term strategy regardless of short-term market ‘noise’. And it’s especially beneficial in asset classes with long cycles, such as commercial property. The structure of investment trusts also means that their managers don’t have to contend with the costs of creating and redeeming new shares – and nor, therefore, do their investors.
In contrast, when an open-ended fund faces client redemptions, the manager will often have to sell assets to meet them. So, when investors withdraw large amounts of money from the fund, the manager can be forced into selling the most liquid assets to raise cash, regardless of their longer-term prospects. Perversely, this forced selling puts the interests of redeeming investors ahead of those that keep faith with the fund. Even worse, the manager may have to impose lock-ups during volatile periods, to prevent investors from withdrawing their money en masse.
Liquidity
The advantages of investment trusts apply especially to commercial property. Property is an inherently illiquid asset; whereas shares and bonds can be sold at the touch of a button, buildings take time and patience to sell. So, by avoiding the need to raise capital when clients reduce or withdraw their holdings, the investment trust structure, is ideally suited to the asset class. That’s why real estate investment trusts (REITs) have become so well established since their introduction to the UK in 2007.
Exposure
And because an investment trust doesn’t have to keep a high cash balance to cope with redemptions, it can stay fully invested in the manager’s chosen assets. That should entail higher overall returns than open-ended funds, as the higher cash holdings of the latter will tend to create a drag on performance when markets are rising. This is a particularly important point for the property sector. Because of the illiquidity of property assets, open-ended property funds are usually compelled to hold between 10 per cent and 20 per cent of net asset value (NAV) in cash in anticipation of redemptions.
This should be a key consideration for investors. If you put money into a property fund, you want all it at work in the asset class. If you wanted a proportion of your money to be invested in cash, you could put it in a bank. Why pay a fund manager to do it for you?
Performance
The ability to use gearing is another important factor enabling investment trusts to achieve higher returns. According to research from Canaccord Genuity, the average property exposure of UK REITs is 131 per cent of NAV, compared with just 78 per cent for large open-ended funds. That gives investment trusts a considerable head start when it comes to NAV performance.
The benefits of that head start are well attested. Over the past decade, UK commercial property REITs have delivered an average annualised NAV return of 7.0 per cent and an average shareholder total return of 10.9 per cent. This compares with just 4.3 per cent for their open-ended peers.
Discounts
The stock market’s inherent volatility creates regular opportunities for long-term investors in REITs. REITs often trade at a discount to NAV, but any discount will tend to narrow over time, allowing investors to benefit when discounts have been exacerbated by irrational sentiment or panic selling. With discounts having widened to around 8-10 per cent recently, contrarian investors may see this as an attractive long-term entry point into UK commercial property.
Income
Another attraction of REITs is their dividend policy. Unlike open-ended funds, investment trusts are able to keep back up to 10 per cent of the income from their assets to smooth out their annual payments. This helps them to deliver a steadier stream of payouts, making them a more reliable vehicle for income-focused investors. And the fact that they can be fully invested means that that income will be higher, all else being equal, than the income from an open-ended fund with a higher cash balance. Over the past decade, UK REITs have averaged an annual yield of 5.3 per cent, compared with just 3.0 per cent for open-ended commercial property funds. Investment trusts are thus an obvious choice for investors who are primarily interested in income.
So, in a market that’s often obsessed with novelty, the venerable investment trust structure might seem like old news. But for long-term investors and for the property sector in particular, it’s very good news indeed.
Calum Bruce is portfolio manager at Ediston Property Investment Company. The views expressed above are his own and should not be taken as investment advice.