investment trusts

Stock market volatility: the investment trust advantage

Amid volatile financial market conditions, investors are understandably nervous about their long-term savings. However, investment trusts have a number of advantages in this type of environment.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

These are tough times for investors. Many have seen significant falls in the value of their savings as financial markets have slipped in response to the COVID-19 outbreak. We cannot predict how markets will behave as the virus progresses, but we believe there are reasons for investors to hold their nerve on investment trusts over the next few weeks and months.

First – and perhaps most importantly - selling when markets have already fallen a long way has seldom been a good strategy for growing long-term wealth. Trying to time the market by exiting at times of crisis and then re-entering in better conditions is very difficult. Markets often see sharp rises just after significant falls, but often the right time to buy is the one that feels most uncomfortable.

For example, in the last crisis the market bottomed out in March 2009. At the time, the economic situation still felt precarious: interest rates were still being cut to new lows, markets were still digesting the failure of Lehman Brothers and the economic consequences of the crisis were unclear. If investors had waited until the situation felt better, they would have missed the bounce. As such, it is usually better to sit tight and wait till the storm passes.

We believe there are reasons for investors to hold their nerve on investment trusts over the next few weeks and months

Collective funds

We believe investment trusts have a number of natural advantages in dealing with difficult markets. In common with all collective investments, investment trusts provide access to a broad and diversified portfolio of investments. Therefore, performance is not reliant on just one or two companies, but a range of different business types and sectors.

Diversification and asset allocation may not fully protect you from market risk.

There are also advantages that benefit investment trusts. At times like this, lots of investors want to sell. For an open-ended fund to meet these redemptions, they will have to sell some of the companies they hold in their portfolio. This is a tough time to do it, market pricing is difficult and volatile. These managers may end up having to sell assets below their real value.

Equally, they may not be able to find a willing buyer for their weaker holdings – or, at least, not at a sensible price. As such, an open-ended manager may be forced to sell their better holdings. This won’t make a lot of difference while the market is selling down indiscriminately, but as the dust settles and markets start to recover, the open-ended manager may find themselves with a weaker portfolio.

Fixed assets

Closed-ended funds have a notable advantage in this respect. They have a fixed pool of assets and don’t have to sell shares in their portfolios to meet redemptions. At times of crisis, it means they are not forced sellers. They can look at markets objectively, even taking advantage of lower share prices to buy more. The effects of this may not be apparent in the short term but may be evident in stronger performance over the longer term.

There are other reasons investment trusts can thrive in this environment. After a period of market weakness, the income from collective funds may come under threat. Companies may cut dividends in response to the crisis. But investment trusts have two layers of protection: firstly, active managers can select those companies that have stronger balance sheets and more resilient dividends and secondly, they can build up a dividend reserve.

There is no guarantee that a positive investment outcome will be achieved.

Many trusts already have a dividend reserve set aside, which can be used in difficult times to support the income to shareholders

Dividend reserves

The investment trust structure also allows the manager to set aside dividends in more buoyant years (up to 15% of dividends per year) and pay them out in lean years. This can help smooth out the dividend stream over time. Many trusts already have a dividend reserve set aside, which can be used in difficult times to support the income to shareholders. Many of the BlackRock trusts have a dividend reserve that can be used to support the payout to shareholders should companies in their portfolio choose to cut dividends.

Investment trusts can also pay dividends to shareholders from capital. This tool is more frequently used in asset classes where the income is lower, but capital growth may be higher – such as smaller companies – but can be another support for a trust’s payout in difficult conditions.

There is also another consideration. It may not feel like it today, but some point, markets will start to recover. As it stands, many trusts now stand on a significant discount to the value of the underlying holdings. As markets recover, investors should get the benefit both from a recovery in the share price and a narrowing of the discount as confidence returns to market. This is not assured, but it can accelerate returns in better times.

This is a difficult time and we understand why many investors are nervous. However, we believe that, over the long term, these moments can provide opportunities for investment trust investors.

Reference to the company mentioned in this material is merely for explaining the investment strategy, and should not be construed as investment advice or investment recommendation of the company.