Share prices can bounce around faster than the prices on funds because of the operation of premiums and discounts – the difference between the value of the trust’s investments and the price the trust trades at in the market.
Independent financial adviser Chris Spear, who runs Spear Financial, says that this has made him wary of using the products in the past, but that this is starting to change – at least for his personal portfolio. "I have always only really used OEICs but I have started using investment trusts for my own money," he said.
"It’s because of the extra potential for upside in the share price, although I still think it’s more of a gamble than an investment."
Spear says he has bought into Standard Life UK Smaller Companies and Baillie Gifford Shin Nippon over the past few months.
FE Alpha Manager Harry Nimmo’s Standard Life UK Smaller Companies trust sits in the IT Smaller Companies sector and invests in small and mid cap businesses, which have greater potential for growth than their large cap rivals, as well as greater potential for loss.
Baillie Gifford Shin Nippon, also a smaller companies fund, invests in Japan, a country that until recently was considered a basket case but has been the fastest-growing market of the year – although it suffered a sharp fall on the way.
Both are therefore high-risk investments and Spear says that trusts make more sense for shorter-term, higher-risk strategies.
"Investment should be more for the medium- to long-term, but with my own money I sometimes want to take more risks," he said.
The risky nature of investment trusts is best illustrated by the performance of the Baillie Gifford portfolio.
Between 13 May and 3 June this year, the fund lost 28.92 per cent of its value, having previously made 69.43 per cent.
By contrast, the MSCI Japan Small Cap index lost 8.94 per cent in the same period after making 31.63 per cent by 13 May.
Performance of trust vs index over 1yr
Source: FE Analytics
The fund is still up year-to-date and well ahead of the index – having made 50.38 per cent to the benchmark’s 31.38 per cent – but the wild ride illustrates the dangers of investing in trusts.
Data from FE Analytics shows the effect of a tightening discount on the price. At the end of 2012 it was trading on a small discount, meaning that it was cheaper to buy the trust than the assets it held at the time.
Share price and NAV of trust over 1yr
Source: FE Analytics
However, it then went on to a premium as the Japanese market soared, before reversing onto a wide discount of 11 per cent when the market collapsed. The highest premium the trust traded on was 10 per cent.
These discount moves increased the volatility of the already sharp changes in the value of the underlying assets – the NAV.
Overall, it has worked to investors’ advantage in the past 12 months, as our data shows the NAV of the trust has risen 54.1 per cent in total return terms, less than the move in the share price.
However, this is a dangerous game to play, and at other times investors will lose out.
Nimmo’s £197.4m trust takes steps to reduce the discount volatility, buying back shares to boost the price when the discount widens.
This is a strategy that many trusts have been employing in recent months and years to make themselves more attractive to private investors.
Our data shows that the share price of Nimmo's trust has been only marginally more volatile than the Numis Smaller Companies ex IT benchmark, with a one-year figure of 19.79 per cent to the 16.37 per cent of the index.
The trust has moved between a discount of 9.04 per cent to a premium of 4.96 per cent in the year.
Performance of trust vs benchmark over 1yr
Source: FE Analytics
Spear remains cautious of using trusts for clients because of these movements.
"I have taken my profits from the Standard Life trust but am sitting in Shin Nippon, which is up perhaps 15 per cent in six weeks," he said. "I could easily lose that overnight if something went wrong."
The adviser does say, however, that he is getting more interested in passive products for his clients, especially those that buy a basket of different assets and try to mirror the returns of the average mixed investment fund.
"I have always been someone who prefers active funds but the low charges are hard to turn down."
He is wary of Standard Life GARS on the grounds of its size, and is reducing his exposure to the £17bn fund.
Many retail investors have been looking to GARS and other absolute return funds as a replacement for bonds, but Spear says he thinks people are over-reacting to the problems with the asset class.
"I am conscious of the bubble story but I’m not panicking. It’s stupid to panic."
"M&G and Invesco are not overly worried; they are big enough and mature enough to take steps to reduce risks themselves, for example reducing duration or looking at financials, which aren’t in as much of a bubble."
"Even if you have a bad year, we are not looking at a 2008-type collapse."