Investing in the Stock Market: Trust in hidden talents

Investment trusts should get a better press, writes Harvey Jones

Some things deserve to go out of fashion (the Bay City Rollers and their tartan scarfs spring to mind) but with others the popularity slump is more surprising. This is the case with investment trusts.

Like the perennially fashionable unit trusts, investment trusts are a pooled investment that places money in a wide range of shares on behalf of thousands of investors. However, they are complex and difficult to understand, and this often blinds investors to their advantages.

"They have much lower charges than other investment vehicles," says Daniel Godfrey, director general of the Association of Investment Trust Companies. "One reason for this is that they don't pay a large commission to financial advisers."

This has held back sales, as where advisers work on a commission basis they will be unlikely to recommend an investment trust if they will earn nothing from the sale. Recommending a unit trust can earn them 3 per cent of the initial money you invest, which comes from your pocket.

Investment trust providers are planning to redress the promotional balance with a pounds 20m advertising blitz in the autumn. That may sound like a lot of money, but is small change for an industry worth pounds 60bn.

Investment trusts can offer better long-term performance than unit trusts, although they are more risky in the short term. "Over 15 years you are likely to get a better return. The downside is that you will suffer greater short-term swings and volatility," says Mr Godfrey.

Low charges are one reason for their better long-term performance. Gearing is another. This means investment trusts are free to borrow money (unlike unit trusts) which managers can use to improve the rate of return. But this is an advantage that can be hard for the average punter to digest.

Investment trusts are publicly quoted companies that invest in other firms, instead of trading in goods and services. Their shares trade on the stock market, which means their price depends on how much investors are willing to pay for them.

So although investment performance has a major effect, there is no direct link between share price and the value of the trust's investments. The share price can be at a premium to the value of the trust's assets, or at a discount.

The sector is currently at an average discount of 14 per cent, so 86p will buy you pounds 1 of shares, which looks like good value. Furthermore, dividends will be based on the full pounds 1 price. "The discount cannot get much wider and is likely to reduce over the next two or three years," says Mr Godfrey.

"The 14 per cent discount makes investment trusts a potential bargain," says Ian Overgage, product manager at Gartmore. He says the marketing campaign should increase the value of trusts by boosting demand and may put pressure on financial advisers. Mr Overgage hopes to see a reversal of the current pattern of investment trust purchase, where only 30 per cent are bought by individual investors, the remainder by large institutions.

Lee Gardhouse, fund manager with Hargreaves Lansdown, agrees that there are signs that recent low performance may be reversed. He says: "Since 1994 returns have been absolutely atrocious and this is the main reason investment trusts have been out of favour. They have been concentrated in smaller companies, Asia and emerging markets, all of which have performed poorly."

However, he believes smaller companies in particular are due a good period of performance and strongly recommends the Fidelity Special Values investment trusts.

Bhavesh Amlani, business development assistant with Rickman Tooze, says investment trusts are most suitable for more experienced investors who have time to research the options. "Discounts mean you can pick up a real bargain, but you do need to be careful, because the discount may widen before it closes," he says. For long-term capital growth he recommends the Primadona Trust managed by Jupiter. The Jupiter is an international fund, so for investors wanting a UK fund, Mr Amlani suggests Mercury Keystone, which has a good record. However, it is trading at a premium of almost 5 per cent, so there will be no benefit from the discount closing.

For those investing for the long term and therefore able to accept a higher risk, he recommends the Baring Emerging Europe Trust, which invests in Hungary, Greece, Poland, Russia and other countries. It has a good record but again is trading at a premium, this time almost 17 per cent. Other trusts are offered by Foreign & Colonial, Friends Provident and Skandia/Newton. If your adviser is reluctant to discuss investment trusts, you can do your research on the internet.

Websites: www.aitc.co.uk (Association of Investment Trust Companies),www.trustnet.co.uk