This article is part of Morningstar.co.uk's Equity Investing Week.
In the last quarter of 2012, equity funds enjoyed €13.7 billion of inflows, according to the latest Morningstar data. That’s an encouraging signal that market sentiment towards equities is improving after months of net outflows from equity funds.
If, like many other investors, you’re considering putting more of your money back into equities, you may want to consider equity-focused investment trusts. Trusts are structured in a unique way that can help investors achieve smoother, higher returns, provided the fund managers act responsibly and invest well.
In this article, we will discuss three examples of Gold-rated investment trusts where fund managers have, in our opinion, successfully used the investment trust structure to benefit investors.
Aberdeen Asian Smaller Companies Trust (AAS)
First up is the Gold-rated Aberdeen Asian Smaller Companies Trust. As the name suggests, this fund invests in Asian smaller companies, which tend to be relatively illiquid and operate in smaller markets. There is good reason to favour the investment trust structure when you’re investing in these kinds of smaller, illiquid assets. By its very nature, the trust structure prevents massive inflows of money when investors want to jump on trends, and it prevents large outflows when they panic-sell. That allows the trust’s manager to focus on his job of investing instead of worrying about potentially having to sell investments at inconvenient times when investors want their money back. This structure allows him to stay invested for the long-term and hopefully reap the benefits of this strategy.
But we think there are more reasons to like this fund. We think the management team is one of the best in its field; it is stable, with significant experience and a long track-record at Aberdeen. The fact that the team is based in Asia is particularly beneficial for investing in smaller stocks, since company meetings play an important role in investment decisions.
The investment process is tried-and-tested over a number of market cycles and has proved its effectiveness. Since the fund’s launch in Oct 1995, it has comfortably outperformed the average fund in its Morningstar Asia-Pacific ex-Japan Equity category. It’s also outperformed the MSCI Asia-Pacific ex-Japan Small Companies index, and that’s without taking excessive risk.
Finally, the use of gearing, another structural benefit, is a constant feature here and has added value over time.
City of London Investment Trust (CTY)
The second fund is the Gold-rated City of London trust (CTY). The fund offers exposure to large FTSE companies and will appeal particularly to investors wanting income from their investments.
The board’s commitment and the fund managers’ skills have enabled the City of London trust to increase its dividend each year for the last 45 years—a record for the industry. Fund manager Job Curtis pays a lot of attention to the dividend yield when selecting equities for the trust and this focus on income as a measure of a company’s value has been paramount to the fund’s success. We hold Curtis in high regard; he has been at the helm of the fund for over two decades and we like the stability this brings, and it has led to the successful implementation of his process. A low management fee gives the fund a distinct advantage over its peers, too.
Additionally, the board has been very effective with using the revenue reserve account—another structural advantage of investment trusts. This account allows the board to save up to 15% of the income they receive each year to help boost dividends in more difficult years, known as 'dividend smoothing'.
Last, but not least, we like the board’s approach to discount and premium management. While there is no firm rule in place, shareholders can take comfort in the knowledge that the board will take action should the discount drift out; in fact, over the last three years, the fund has been trading at a moderate premium, which has enabled the board to issue shares.
BlackRock World Mining Trust (BRWM)
The third and final trust is the Gold-rated BlackRock World Mining Trust, which will appeal to investors looking for exposure to natural resource companies. (This most likely has the smallest audience out of the three funds.)
The closed-end structure is especially suitable for this specialist, sector fund because it restricts inflows and outflows. Manager Evy Hambro runs a mirror open-end fund, which experienced outflows of more than £1 billion in 2008, only to see nearly £2 billion of inflows the following year. At the trust, however, Hambro didn’t have to deal with the inflow/outflow distraction. This additional flexibility and ability to cut though the short-term noise resulted in the trust returning an additional three percentage points annualized over ten years.
More recently Hambro has used the fund’s loan facility (another closed-end fund feature) to partly-finance a purchase of a 2% royalty from an iron ore mine and enhance the trust's income over time. This is the first such use of a loan at an investment trust and a demonstration of the flexibility it brings.
The fund's management team is strong, with deep knowledge and experience in this sector, and the process is thorough and has been applied consistently over the years.
Conclusion
All said, investment trusts are a little more complicated than their open-end peers. Nonetheless, they provide additional tools for the fund manager to use on behalf of shareholders, and when these tools are used wisely, they can serve to enhance investment returns.
