Investment trusts have been around since 1868, weathering in that time the world wars, the Great Depression, the 1970s recessions, the financial crisis of 2008 and the pandemic. Now some peers in the House of Lords are concerned that a quirk of regulation could be their undoing.
How? It’s all down to the way the Financial Conduct Authority (FCA) deals with two pieces of EU-retained legislation, known as Mifid and PRIIPS — two acronyms (standing for the Markets in Financial Instruments Directive and Packaged Retail Investment and Insurance-based Products). These tend to trip off the tongues of those who work in financial services with such regularity it can sometimes feel like you’re having a conversation with Beaker from The Muppets.
The way the FCA interprets these pieces of legislation compels investment trusts to report their costs in the same format as open-ended funds. The result is that investment trusts look more expensive than they actually are.
Let’s look at Temple Bar Investment Trust. It is popular for its value investing approach — the strategy of buying a company’s stock for less than its true worth.
In Temple Bar’s report and accounts, the ongoing charge — an expression of the company’s management fees and operating expenses — is 0.56 per cent. But if you look at the Key Information Document (KID), devised by regulators to help investors make more informed investment decisions, the annual “cost impact on return” is 1.48 per cent; and if you exit after five years you’ll pay £712 in total on an example investment of £10,000.
It is little wonder that pretty much everyone involved in the industry of 359 companies — representing total assets of £275bn — wants to go back to 2018, before Mifid and PRIIPS arrived.
Doug Brodie, chief executive at Chancery Lane Retirement Income Planning, says: “There are 173 words in the 10 commandments, 266 in the Gettysburg Address . . . There are 1,034 words in the Temple Bar Key Information Document. I bet you can’t find one person in the FCA, Financial Ombudsman Service, Association of Investment Companies, an MP or any person in an investment company who will confirm that is clear and relevant for every retail investor considering an investment trust.”
These metrics are fine for open-ended fund fees, which deduct management fees when the daily unit price is updated. But for investment trusts, fees and costs simply reduce the net asset value that an investor has a stake in by owning shares. Investors will also pay broker trading and stamp duty fees to own those shares.
Like most investors, my eyes glaze over when I read a KID. I’m much more reassured by Temple Bar’s report and accounts: “The company’s ongoing charges ratio has remained relatively consistent and compares favourably with peers in the UK equity income sector of investment trust companies.”
Let’s remember that investment trusts are companies that investors buy shares in. As an investor, I’m most interested in the trust’s share price and the dividend it pays. If I was investing in Legal & General shares, I wouldn’t necessarily look at the operating costs of the investment division or the technology costs. But this is what the regulator’s “cost disclosures” ask you to do, simply because there’s a requirement to compare investment trusts with open-ended funds.
It’s a ludicrous position and the Association of Investment Companies (AIC) is lobbying hard for change, this week calling on the Treasury to announce its decision on whether investment companies should be treated as Consumer Composite Investments (CCIs) — the Treasury finished consulting on this in January, and says the policy is “near-final”, which will determine the disclosure requirements that apply to all funds marketed to UK retail investors.
The AIC says removing investment companies from the CCI regime is “the swiftest way” to resolve the issues.
But what’s actually at stake here? The House of Lords committee claims misleading costs are discouraging investors from putting as much as £7bn a year into investment trusts — “money that some of the more domestically-focused trusts could channel into the UK economy”. The committee is calling for reform so investment trusts can enter zero into the appropriate column for ongoing fund charges.
However, when I asked the AIC for the evidence of how cost disclosures affect the sector it pointed to changes in discounts and shareholders.
Trusts can trade at a discount or a premium to their underlying net asset value. Discounts have widened dramatically but this isn’t all the fault of cost comparisons. The AIC admits higher interest rates and investors moving from investment trusts to bonds have also had an impact on widening discounts.
Meanwhile, AIC data shows a marginal shift in shareholders from wealth managers to institutions — a 1 percentage point share increase from December 2022 to 2023. This is largely accounted for by movements in the shareholder base of renewable energy and infrastructure trusts.
I think the decline of the sector has been somewhat over-egged. In fact, in 2021, investors gave a vote of confidence to investment trusts, boosting industry assets in the UK to a record £277.6bn (€333bn). That is despite the cost disclosures issue rumbling on.
Plus, regulators have form on misleading projections for products that delivered well for customers. Financial advisers recall investment illustrations based on a minimum return of 4 per cent even when investors were in a cash fund returning little more than 1-2 per cent at the time. Or insurer Royal Sun Alliance having to include a separate printed flyer with its with-profits illustrations explaining that the regulated projection was meaningless (and why).
As a retail investor, I’m going to take a more optimistic outlook. If the regulator continues to impose its “one size fits all” approach, making investment trust costs look unattractive, there may be an opportunity.
A fairly exclusive group of investors rely on them for retirement. Drawing the “natural income” from investment trusts is a tried and tested strategy that only a handful of financial advisers recommend.
If you can buy an investment trust at a 10 per cent discount, and its underlying assets mirror those of an open-ended fund which yields 3 per cent, then you’ll get a 3.33 per cent yield for the same money invested in the investment trust, because of the dividend.
So if you haven’t already joined the investment trust fan club, perhaps now is the time, before the reform requested by the Lords actually happens and discounts (possibly) become thinner on the ground.
Moira O’Neill is a freelance money and investment writer. X: @MoiraONeill, Instagram @MoiraOnMoney, email: moira.o’neill@ft.com
