Personal finance: Looking for a fund of knowledge

There are signs that the investment trust sector is coming back to life. Now you must make the right choices. By Tony Lyons

If the product you are selling is good enough it needs no marketing, right? Wrong - or at least, wrong as far as the Association of Investment Trust Companies (AITC) is concerned. The AITC, a trade body which represents investment trusts, has raised nearly pounds 16m to fund the first year of an advertising and marketing campaign to promote its members' products. It aims to attract more private investors and to push up their prices.

But new investors will only buy investment trusts if they can be shown to provide good performance and good value for money. In a series of articles we shall look at how investment trusts can be used to meet different investment aims and how they can be packaged to for tax planning, saving for retirement, school fees and saving for children.

When it comes to investment planning, most investors look for long-term growth. To help make your decision, you are usually told to look at charges and past performance. On the charges front, investment trusts score well. Unlike unit trusts, with which they are often compared, they have no initial charge, although you will have to pay 0.5 per cent Stamp Duty on purchases as with any other equity deals, and you may have to pay a fee to a stockbroker or adviser.

When it comes to past performance, over the very long term, 10 years or more, most investment trusts have done well. Since the shake-out in the stock market last summer, they have begun to outperform the FTSE All Share Index.

But apart from a number of specialists, including split-capital investment trust shares and a couple of high-risk funds, most have underperformed their unit trust rivals since 1993 let alone beating the rise in the FTSE All Share index. This is largely because they fell out of favour with investors when a number of new issues in the early 1990s soaked up all the demand for shares in the sector.

With low demand, discounts - the gap between an investment trust's share price and the value of the assets it holds - began to widen. Low demand means that the share price can be less than so-called "net asset value", or NAV.

At the same time, institutional investors such as pension funds and life assurance companies, who hold around 70 per cent of investment trust shares have been sellers of the sector. In the past, they bought into investment trust shares because they offered diversified portfolios, often with substantial overseas holdings. Nowadays, the larger institutional investors have built up investment departments with their own fund managers who want to invest directly in stocks and shares rather than indirectly through investment trusts.

Since last September, there are signs that the investment trust sector is starting to come back to life and the AITC campaign should help this along.

"When looking for an investment trust to provide growth, forget about complicated structure of the funds, and work out what risks you are prepared to take," says Sue Whitbread of Chartwell Investment Management, fee-charging independent financial advisers in Bath. Those who want a low-risk investment, should look at funds that invest in major companies in the UK and internationally. Higher risk are those that invest in the USA or Europe. If you do not mind high risks, there are plenty of funds that invest in smaller companies and emerging markets, including a number that just invest in a single country.

If you know a little about equities before buying, look at asset allocation of the fund and its portfolio. "See if the fund manager has the right stock in the right place," says Kim North, of Pretty Financial.

"You might be surprised at the quality of the investments," says Jason Hollands of BESt Investment, a discount-broking and advice firm in London. "If the holdings look good and the rest of the market hasn't caught on, the trust could be attractive. Much is made of the fact that most investment trusts trade at a discount, currently averaging 14 per cent. This means the shares are trading at 14 per cent below the net asset value of the fund. But this also means that you can buy pounds 1 worth of shares for 86p. Furthermore, you will receive dividends based on the pounds 1 worth of underlying assets.

Jeremy Tigue, manager of the pounds 2.4bn Foreign & Colonial Investment Trust, the oldest and largest of the funds, says: "What matters is the share price. Investors should care more about the share price going up than what is happening to the discount."

Unlike other collective funds, investment trusts can borrow money. Called "gearing", they do this if the managers believe they can get a better return from the investment than the interest they have to pay. Managers can come unstuck, mind. A number of funds geared up early last year in time to see international share prices dive during summer.

THIS IS WHAT THE IFAs RECOMMEND AS MEDIUM-RISK INVESTMENTS

Jason Hollands, of BESt Investment (0171 321 0100), favours the growth fund RIT Capital Partners, "a broadly diversified international fund standing on a discount of around 10 per cent. For first-time investors, I also recommend Foreign & Colonial, Alliance and Scottish Mortgage."

Sue Whitbread of Chartwell Investment Management (01255 321700) likes "Personal Assets, on a 4 per cent premium, where manager Ian Rushbrook, has his own money and takes a hands-on approach. If he feels the market is getting jittery, he'll go heavily into cash.

Roddy Kohn, of Kohn Cougar (0117 946 6384) selects "Gartmore Scottish Capital shares, currently on a 33 per cent discount with a wind-up date of July 2001. While a risk, with its high-quality portfolio, this gap must close before then. Even if assets do not grow, this still gives a 26 per gross reduction yield.

Kim North, of Pretty Financial (0171 377 5754), picks Witan for lower risk investors, "with Spectrum, Gartmore European and Invesco Asian or Japan for a higher risk.