Investment Trusts - why so unloved?

It's weird. Almost all my friends own unit trusts. Quite a few of them own shares. But very few of them own investment trusts. I wonder why?

Investment trusts don't have a very high profile. They don't advertise like the big unit trusts - since they're closed-ended, it wouldn't do them much good if they did, because they can't make more shares to soak up extra demand.

However, investment trusts can sometimes offer very good value. To see why, you need to appreciate the difference between the two. An investment trust is a company which issues shares, only unlike Glaxosmithkline or British American Tobacco its business happens to be investing in other shares. It can, usually, borrow money if it wants to, and the share price fluctuates depending on what the stock market thinks it's worth.

On the other hand, a unit trust or OEIC is a fund which can issue as many units as there is demand for. If an investor wants to sell their units, the OEIC buys them back. It always bases its price on the asset value of the shares, so you will never pay more than it's worth - but you can never pick it up for less, either.

Now the big advantage of the investment trust is that you can generally buy them at a discount to their net asset value. Currently, quite a few are trading at 10-15% discounts.
You may even find cases where there is a unit trust and an investment trust with similar portfolios and managed by the same fund manager, but you can buy the investment trust at a discount. That's definitely an offer worth taking - you won't find bargains like that in Harrods' sale!

On the other hand the Asian income funds and some of the most sought after equity income funds are trading at a premium to their NAV. That's not completely illogical - it suggests investors think the prices of the underlying equities will appreciate. However, it does mean you're not necessarily getting value for your money and, as a value investor, I've stayed clear of these sectors for the last six months precisely because of the premium valuation.

Discounts do widen and tighten over time. One good strategy that has sometimes worked is to look at the trend, and try to buy investment trusts which are valued at a larger than average discount.

How would one choose an investment trust? Well firstly you can certainly look for the right sector or style - you might choose Asian funds, income funds, or specialist sector funds.

You might also use a stock screen to find funds with high yield (warning, there are some misleadingly huge historic yields - mainly VCTs which are paying out at the end of their lives), large discounts, or which are at the top or bottom of their trading range - just as you would for equities.

Next you'll need to run through the management reports. Picking funds just on their performance is likely to give poor results. How clued up have managers been? Have they always 'told it like it is', or have they tried to find excuses for poor performance? What is their investment style? You will want to look through the list of top holdings, and also the geographical distribution of the funds. For instance I liked the look of one emerging market fund - till I found out it was nearly all in Brazil and didn't have the Indian and Chinese exposure I wanted.

You'll also need to check the gearing, and the total expense ratio (usually given in the fund's reports). You will probably also want to look in detail at how the fund's management is remunerated.

Finally, as with any company, it's important to check the liquidity of the shares. The larger investment trusts are very liquid, but at the smaller end of the market - particularly with secondary market trading of VCTs - liquidity can be tight, and spreads very wide.

By the way, one of the things I like about investment trusts is that generally I can sell my shares easily - click, hey presto and it's done. Whereas some unit trusts still only have one redemption day a week - you have to wait till Friday and if the market has moved in the meantime, that's tough - and even with once-a-day valuations, settlements can take a while.