The market volatility of the last two years has had a disastrous impact on price of investment trusts. In the 15 months between September 2007 and December 2008 the Principal Capital Investment Trust saw its price fall by 86 per cent, from over 110p to 15.75p.
During the same 15 month period the average fall for a fund within the Unit Trust and OEIC UK All Companies sector fell 35 per cent.
Performance of funds vs UT UK All Companies sector
Source: Financial Express Analytics
Investment trusts are particularly susceptible in volatile markets because they suffer a double blow – taking on both the market risk of the underlying investment and that of the stock itself. So as the underlying investment drop in price the IT becomes less appealing, reducing demand for it and thus the price falls.
Conversely, the price of a unit within a unit trust or OEIC is not affected by supply and demand. Rather, it is entirely dependent on the assets under management of the fund and the number of units in issue. So we saw that unit trusts and OEICs investing in UK companies did not see the same falls in unit price as ITs did.
But as Annabel Brodie-Smith argues, it’s not all bad news. These low prices offer potential investors the chance to snap up a bargain. The same double blow seen when markets are falling can work to the benefit of investment trusts when the markets are rising.
Investment Trusts are also able to provide income at times when dividend yields from companies have dried up; this is thanks to the revenue reserves that they are allowed to build up in good times to maintain an income supply to investors when times get tough.
Moreover, investment trusts are able to borrow money to "gear up", which can enhance returns as they are able to use the money to invest in shares which produce higher returns than they are paying in interest for the borrowed money. Of course this ability to become geared brings with it a greater risk too. Risks that have been only too obvious in the last two years, but in a rising market can bring great rewards.
In addition, unlike unit trusts, investment trusts have no restrictions on how they invest. They can hold property as an investment, for example, and also buy shares in unlisted companies. Again, this is riskier, but can mean potentially higher returns.
A final reason to consider investment trusts is the fact that they tend to have lower costs than their open-ended counterparts; this is because they don’t pay commission to advisers.
So if you have a long investment timeframe and are willing to put up with lots of ups and downs, now could be the time to get into investment trusts.