Accessibility: How do we deal with the elephant in the investment trust room?

The investment trust sector is enjoying a bumper year, with fundraising currently at a 13-year high of £14.3bn and assets soaring to an all-time peak of £278bn by the end of November.

There is an elephant in the room, however. Why aren’t closed-ended funds used by more investors, who collectively hold £1.55tn in open-ended funds?

Firstly, accessibility may be an issue for wealth managers and individual investors. Investment trust shareholders are a mix of institutions, wealth managers and individuals. This mix has changed over time and varies a lot between investment companies.

To generalise, institutions and wealth managers are bigger holders of alternative strategies, like infrastructure, property and private equity. Professional investors’ appetite for alternative strategies has driven a record £10bn of secondary fundraising so far this year.

New trusts have tended to be specialist offerings too, and sometimes these have floated on the London Stock Exchange’s special fund market, as was the case for Cordiant Digital Infrastructure (CORD) in February and Digital 9 Infrastructure (DGI9) in March.

‘This market is aimed at professional and institutional investors, so excludes retail investors and often wealth managers depending on the interpretation of the firm’s compliance department,’ said Dan Boardman-Weston, chief investment officer at BRI Wealth Management.

Individual investors make up more of the shareholder register of mainstream equity investment trusts. Some of the largest investment trusts are very well established among individual investors.

For example, Hargreaves Lansdown is the largest investor in Scottish Mortgage (SMT) through its dealing platform. With a market value of £21.4bn and a place in the FTSE 100, it is the largest and most liquid investment trust by a long chalk.

Regulatory announcements show that the Baillie Gifford global flagship issued shares worth £354.9m during the four weeks to 25 November. ‘It issued shares nearly every day but even for this mega trust, the largest individual deal size was £27.7m,’ said IpsoFacto Investor director David Liddell.

While that is likely to be sufficient to satisfy the demands of private clients, it may not be ample for the largest wealth managers. Relative to a £2bn portfolio, it would only amount to a 1.385% stake.

Although many trusts issue new shares, typically to the more traditional private client stockbrokers who are used to dealing in investment trusts, deal size can be a particularly limiting factor for smaller trusts.

Many trusts are limited to annual issuance of 10% of their shares without asking existing shareholders for permission. Average daily trading values vary from millions of pounds at the largest investment trust, right down to five-figure sums at the smallest ones, according to Nick Britton, head of intermediary communications at the Association of Investment Companies (AIC).

In addition, investment trust boards often want to issue new shares only when they are standing at a premium to net asset value (to save diluting existing shareholders) – ‘arguably just the time when investors should not be buying’, said Liddell.

Liquidity, or tradability, is a particularly big issue for wealth managers running off-the-shelf model portfolios. They require immediate and often substantial access when making changes to their asset allocation models. If an investment trust has a low average daily volume, it is very difficult to trade across client portfolios at the same time and by the same amount.

‘Trusts are often not liquid enough to replicate exposure across broad client portfolios,’ said Kamal Warraich, an investment analyst at Canaccord Genuity Wealth Management. ‘Trading can be lumpy and particularly difficult to execute during periods of heightened volatility.’

The way in which many platforms handle investment trust trades – through bulk daily dealing – compounds the issue.

‘I’ll probably get lots of adverse comment from investment trust aficionados for this, but one of the problems with investment trusts and lower take-up is that platforms aren’t very good at dealing with them – not all platforms, but many,’ said Ben Yearsley, co-founder of Fairview Investing.

‘Putting them in model portfolios where bulk daily dealing happens is just not conducive to running portfolios efficiently. What if you are switching £3m, £4m, £5m in one go?

‘Platforms and most open-ended funds can deal with that level without an issue. Granted there might be a dilution levy, but overall the process is seamless, especially if you have good relations with the fund managers. But try doing that with a trust.’

For these reasons, larger wealth managers tend not to use investment trusts in their models, though may include them in bespoke portfolios. Even then, wealth managers typically have a minimum size of investment trust they are prepared to consider.

‘This could be set at £100m, £200m or higher,’ said Britton at the AIC. ‘These thresholds have been rising over time as wealth managers have consolidated and become larger.’

With more than 60% of investment trusts below £500m in size, for many wealth managers a ‘significant proportion of the universe is un-investable’, according to Oliver King, a research analyst at WH Ireland.

‘Participating in this portion of the market would see firms taking outsized stakes in investment companies and moving share prices meaningfully when they deal in them,’ he said.

As a smaller wealth manager, it can access ‘many of the smaller names’ for clients. It tends to use these for discretionary clients, examples being Montanaro European Smaller Companies (MTE) with a market value of £385m and Octopus Renewables Infrastructure (ORIT) at £530m. In its models, it holds some of the larger, more liquid trusts, like the £765m BMO Commercial Property (BCPT) and the £2.8bn International Public Partnerships (INPP).

Yearsley likes investment trusts and has many in his own personal portfolio, but importantly for him, he can ‘choose when to deal and whether to accept the price, and my small trades won’t affect markets’.

‘I always think market makers see wealth managers coming – placing larger trades can often bump up the price,’ he said.

This brings us onto another salient point – the bid/offer spread that investment trust shares are subject to. Simply put, that is the difference between the price at which you can buy a share and the price at which you can sell it.

As King points out, market makers tend to ‘demand more compensation’ for dealing in less liquid trusts and at times of elevated market volatility. Other factors that can affect the spread include the popularity of the trust, number of market makers and, indeed, size of the trade.

Wide spreads can complicate ownership for individual investors, too. One who recently posted on our forum, ‘Mr TIPS’, found that the spread widened and offer price dropped by 1.25% if he wanted to sell his entire £100,000 holding in the £977m BlackRock World Mining Trust (BRWM), ‘which I would have guessed was fairly liquid’, compared to just a few thousand pounds worth.

‘It is often more efficient to sell a large position in not very liquid stuff in a series of smaller trades than one big one,’ responded another, ‘Bulldog Drummond’. Few ITs [investment trusts] are very liquid even if they have a tight spread.’

This all sounds rather complicated and, indeed, the extra work involved in understanding investment trusts acts as a headwind, too.

‘The answer is pretty simple – and I say this as someone who was a fund selector at a wealth manager – closed-end funds are simply more complex,’ said Monica Tepes, investment companies research director at finnCap.

‘Discount risk and liquidity issues are just two of the wider range of complexities that need to be understood. The question is – why should one spend relatively more time and effort in considering these investments?’

For Tepes, the answer is two-fold: typically superior long-term returns and access to a wider range of asset classes and strategies, some of which are inaccessible through open-ended funds.

Fortunately for investors, ‘liquidity needn’t be a dealbreaker’, said Britton. One potential solution for wealth managers is to run assets in a unitised fund rather than a model portfolio.

‘The economic effect for the end investor is very similar but the wealth manager has more flexibility to manage rebalancing and trading within the fund structure, without having to worry about the varying trading costs and model portfolio functionality offered by different adviser platforms,’ he said.

Developing a network of contacts among trusts and brokers can also help. Sometimes, trusts will engage with large wealth management firms to gauge interest, especially if they expect to issue a significant number of shares, and brokers will facilitate selling activity by calling around to see if there are buyers.

‘We’re fortunate enough to be a major player in many trusts and have built up a significant brokerage network over the years,’ said Warraich at Canaccord.

When it comes to overcoming widening bid/offer spreads, one way is to initiate a limit order – a ‘buy limit’ (an order to buy a share that is triggered if the offer price drops to or below a set price) or a ‘sell limit’ (an order to sell an existing share that is triggered if the bid price rises to or above a set price).

Another tool is a ‘stop loss’, whereby an investor can ask a broker to trade at a specific price. This is not without its risks, however. ‘In some cases, a share price that is falling could “gap”, moving straight from £1.20 to 90p say, which could inadvertently trigger a stop loss to sell your shares – and maybe at that price you wanted to buy more instead,’ added Warraich.