The ability to gear is a double-edged sword that can worsen returns in down markets. Widening discounts can also accentuate downward market moves.
This potential for additional volatility needs to be balanced against the benefits of the closed-ended structure for clients who have time on their side.
It also needs to be remembered that not all investment trusts are riskier than all open-ended funds. There are very conservatively managed investment trusts, which do not use gearing, have policies to limit discount volatility, and invest in carefully balanced portfolios of mainstream assets.
If you draw the 'too risky' line so that every single investment trust is excluded from consideration, then a large portion of the open-ended universe will also fall on the wrong side of that line.
To return to suitability, what matters are the risks and potential rewards of a particular investment, in the context of a particular client’s needs and objectives.
Accessing illiquid assets
When it comes to accessing less liquid assets, from small-cap equities to property to unquoted companies, questions of risk and suitability look very different.
Open-ended funds that invest in illiquid assets present the risks of trading suspensions and fire sales of assets to fund redemptions.
Investment trust shares continue to be traded on the stock exchange even during very difficult times, such as March 2020. Their discount will widen, and it may well be a very bad idea to sell at these times. But you can do so if you wish.
Perhaps more importantly, the manager of the investment trust does not have to sell underlying assets to fund redemptions because those investors wishing to sell their investment trust shares do so on the stock market, to other investors.
This makes the closed-ended structure of investment trusts more robust and resilient, enabling investors to capture the long-term benefits of investing in less liquid assets without a fund manager being forced to sell, or buy for that matter, at a bad time.
If property or other less liquid assets are part of a client’s portfolio, it is highly likely that the closed-ended structure of investment trusts will be the more suitable structure.
The FCA has already tacitly accepted that daily-dealing open-ended funds that invest in property are not fit for purpose. It launched a consultation last year proposing that notice periods of 90 or 180 days are introduced for such funds.
If open-ended property funds are not fit for purpose as they are currently constituted, it is hard to see how they could be suitable for any individual client.
There is a selection of investment trusts that invest directly in UK property, including generalist commercial property portfolios (in the AIC’s Property – UK Commercial sector), warehouses (Property – UK Logistics) and residential (Property – UK Residential).
