The funds that got lost in the wilderness

Shunned by savers after scandals and share slides, can investment trusts find favour again? asks Sam Dunn

Time was when a TV advert could get away with suggesting that a woman preferred the art of the investment trust to sex with her husband. But that was in the late 1990s, when markets were bullish. A multi-million-pound advertising campaign was launched by the Association of Investment Trust Companies (AITC) based on the notion that a well-managed trust could generate far more excitement than a bedroom romp.

Since then, unlike sex, trusts have gone out of fashion. "They are simply not popular at the moment but their time will come again," says Ben Yearsley, investment manager at independent financial adviser (IFA) Hargreaves Lansdown. "It's swings and roundabouts. It's not a question of right or wrong as to whether you opt for an investment or unit trust - it's just a matter of choice."

Three and a half years of poor stock market returns have dented people's enthusiasm for most equity investments, not just trusts. But the funds have encountered problems of their own. The split-cap investment trust scandal, in which products were wrongly sold as low risk, was a disaster for the industry.

The subsequent investigation by the Financial Services Authority into savers' losses cast doubt over the sector's prospects, with some fund managers now having concluded that there is no future for investment trusts.

Jonathan Harbottle, director at fund manager Liontrust, brands investment trusts as "archaic"; his company is set to wind up the one it currently offers and relaunch it in a different form.

Investment trusts have also been undermined by their complexity: they are much harder to understand than unit trusts. Their benefits are difficult to see, too, especially at a time when interest rates are low, and savers are demanding simple, transparent financial products.

An investment trust is a company listed on the Stock Exchange. It invests in other companies' shares, can borrow money to try to boost investors' returns, and often trades at a "discount" to the value of its underlying assets. Annabel Brodie-Smith, communications director at the AITC, says this means you can buy into a trust at a price lower than that reflecting its assets' true worth - benefiting from income streams generated by shares that are worth more than you would normally be able to buy them at.

However, it all adds up to slightly higher risk, warns Paul Ilott, senior adviser at IFA Bates Investment: "There is a lot to think about. For some investors, it adds another layer of complication to the product compared to unit trusts."

You also need to be aware of other risks. A manager's decision to borrow money to buy more stock may help fuel growth when shares are rising, but in a falling market the extra debt can eat away at the trust's value. And although a discount may offer a cheap way into the stock market, the value of your investment trust share price may not reflect the worth of the underlying shares.

Mr Ilott has seen little client interest in investment trusts in the past year, and a similar picture is painted by Colin Jackson, a director at IFA Baronworth. During the past 12 months, Mr Jackson has hardly touched the trusts for his clients, who don't want "anything with a share-related risk".

Figures released last month by the AITC bear this out: money put into investment trust individual savings accounts (ISAs) is falling. A total of £21.6m was invested in such trusts from 1 April to 30 June this year, down by 41 per cent on the same period last year.

But it would be wrong to dismiss investment trusts as savings vehicles, says Mr Yearsley at Hargreaves Lansdown. The initial cost of buying into a trust (usually 0 to 4 per cent) and the annual management charges (0.25 to 1 per cent) make for a typically lower cost ratio than with most unit trusts. Investors can reduce costs further by investing through many trusts' savings schemes.

"There is a trade-off between lower costs and a slightly higher risk," he says. "For example, in a falling market, it's better [to be in an investment trust] because you won't [typically] see fund outflows and managers won't have to sell off stock."

He recommends F&C's £2.1bn trust as ideal for those investing in this type of vehicle for the first time. Figures from ratings agency Standard & Poor's reveal modest growth for F&C's trust for the five years ending 15 September 2003; a £1,000 investment would have grown to £1,217.50 - an increase of 21.75 per cent. During the same period, however, the FTSE All Share index rose by just 0.95 per cent.

If you are considering investment trusts, ask yourself whether your priority is to generate income, boost your capital - or both. Essentially, the aim is for the share price of your investment trust to grow, so make sure you check the mandate and the specific aims of individual trusts. As with unit trusts, risk profiles vary between investment sectors; putting your money into a technology fund exposes you to a higher risk than a more general fund but also offers a chance of higher returns.

Investment trusts can usually be held in an ISA, protecting any gains from the taxman. And there are also savings schemes available to suit those with smaller amounts to invest.

Contacts: AITC, www.aitc.co.uk; Standard & Poor's, www.funds-sp.com