Investor Education: Part 2 - Types of investment trusts


#1

This is part two of a six part course on investment trusts that’s been written and produced by Sarah Godfrey from Edison Investment Research. It’s des
[See the full post at: Investor Education: Part 2 - Types of investment trusts]


#2

Excellent article and very informative. I’d like to make two comments if I may - some of these actually arose from the discussion on offshore property companies converting to REIT status (yes, I wrote that article, sorry to beat my own drum!)

1.Until 2009 it was less tax efficient for a UK investment trust to hold bonds:

Quite right. Since 2009 it is possible to receive interest income and pay it out to shareholders as an interest distribution - the one can be netted off against the other, so no tax is payable by the company - the latter is effectively a conduit - money in, money out. Interestingly, the poster @arkwelder mentioned that Hg Capital was doing this - not a bond fund but a private equity outfit. And of course it makes sense for private equity funds do take a lot of debt securities in the companies in which they invest.

  1. More investment trusts are taking on real assets

Until 2012, an investment trust was only permitted to hold “mainly shares or securities” - if it wanted a property investment, it could only take a limited amount directly, OR it could have a larger portfolio by doing it through a subsidiary.

It was once possible to hold direct property between 1996 and 2006 - there were special rules drawn up for a special type of trust called a housing investment trust -geared towards social housing, but no one was interested - not a single housing trust has ever been set up (there’s even been a question in Parliament about this).

Now land has been added to the list of assets that can be held directly, and this is fine if the object is capital appreciation, for ITs are exempt from CGT. However, the income is still taxable - unlike the case for a UK REIT. It will be interesting to see how many standard ITs take on property investment.


#3

It is a very well produced and easy to read guide, both this one and part one. I am an existing investor in investment trusts but it’s only recently that they’ve become my main investment vehicle.

I’ve moved across to them because I became convinced by the better performance and I love that they have an independent Board, something that isn’t discussed anything like as often as it should be.

There is a lot more information appearing on investment trusts in the Telegraph and Mail as well as websites like this one and the AIC website which I recommend anyone uses too.

Some of the best information can be found in the forums here and sometime son Motley Fool. There are some very knowledgeable users of sites like these @arkwelder is one of them but there are others too whose names I can’t instantly recall @jamespigott (?) and Luniversal on Motley Fool.


#4

…incidentally @satwaki-chanda I’m astounded that there exists in legislation at least, housing investment trusts. Why when we have a chronic shortage of housing haven’t these taken off I wonder?

Perhaps because funding for social housing is cheap because of low interest rates. I could foresee the yield they would deliver being attractive to savers.


#5

@jkstowe

Yes its absolutely true. They were introduced in around 1996, but never really took off. I still have a copy of the legislation - it is very narrowly defined and it really wasn’t any use to anyone.

Here’s the quote from Hansard: a question asked in 2009:

“Housing Investment Trusts, known as HITs, were introduced in the 1996 Finance Act. No HITs were ever created. Legislation creating the HIT regime was repealed by Finance Act 2006 following two consultations, during which there was no opposition to repeal.”

http://www.publications.parliament.uk/pa/cm200809/cmhansrd/cm090721/text/90721w0125.htm#09072324001570

They were repealed in 2006 because REITs were introduced - it was thought that this would help, but it was too difficult to start a REIT from scratch - various hurdles like the entry fee and the listing requirement - you had to be on the main exchange, rather than AIM. Until recently most REITs have been in commercial property. Rules have been relaxed since 2012 - how far they’ll help we shall have to wait and see

 


#6

Given the concerns about potential liquidity issues in bond markets, then one would think that a closed-end structure would be the ideal format to address this issue. I look forward to the first launch of an IT which focusses on investment grade bonds…

Or not. The problem being ‘the bond bubble’, so expectations of rising interest rates leading to capital losses, and a low yield to boot, at least initially. Who would want to buy into that? And which management company would want to try and launch a fund that might be expected to fall in value? But if this is the near-consensus viewpoint then perhaps a bit of contrarianism might be timely?

Whilst even a conventionally structured IT would be of interest in itself , a company with a bit of imagination might think about creating an IT with multiple share classes with different maturities which contain bonds of the appropriate durations. Perhaps the option to periodically switch between classes too - although this might then introduce problems in the event of the underlying bonds being illiquid.

Undoubtedly, there would be problems here that this rather simplistic idea hasn’t taken into account. But the potential benefit to ordinary investors, who themselves lack sufficient capital to be able to buy many investment-grade corporate bonds, could potentially be immense. Once the initial asset purchases have been completed there should be very little need for them to be altered, so the management - and therefore, management charges - ought to be minimal.

OK, a flight of fancy, perhaps, but we don’t get anywhere without a bit of imagination!

+++

Re. Housing Investment Trusts. There was an attempt to launch one of these in 2001 (before checking just now, I did think that it was earlier than this). The problem (or ‘a’ problem?) was that it was structured as a fixed-life split capital IT with income and capital shares. The IPO had to be pulled, though, because the income share class was heavily oversubscribed, whereas there was next-to-no interest in the capital share class. All before the ‘splits scandal’ broke into the open, so this wasn’t a direct contributor to the cancellation (as fas as I am aware).

A residential REIT was launched on AIM late last year, but currently it is miniscule (sub £4m, Mill Residential REIT). However, there is the intention to raise further capital this year, which should help to reduce the effect that any fixed overheads has on the amounts of income that will be available for distribtion.

If I had a specific interest in this particular REIT then I would wait for one of the proposed raisings, and either buy at the IPO or in the secondary market just afterwards. Buying into the company as it is now is just likely to bump up the share price further, reducing the yield on purchase in the process. In my view, better to wait for new capital to be available which can be used to increase the number of properties in the portfolio, which currently numbers seven.

 

@satwaki-chanda, @jkstowe


#7

@arkwelder I was reading, I think it was on here but I can’t remember the name of the fund or trust it was about. What the article was stating was something to the effect that investment trusts bond funds (if I can call them funds), are allowed to invest in a sort of bond where the interest rate moves in alignment with either inflation or interest rates. Also they came with more protection.

I personally find bonds the most complicated investment to understand. To me it’s like they’re speaking another language, but maybe I’m just dim.

On another note…this type of course or information should be taught to kids in schools. I’m no expert in this stuff but at least I know a little but most of my mates don’t have a clue about any of this, though I will (try) pass it on to them.


#8

@LettsDoIt, you are probably thinking of Henderson Diversified Income. This, however, is a quite different animal to the type of fund that invests in investment-grade bonds.

HDIV largely invests in secured loans and high-yield bonds; the interest received from these loans is what would normally be aligned with interest rates. But ‘secured’ and ‘come with more protection’ need to be put into context: the credit quality of these loans is generally low, i.e. sub-investment grade which is sometimes referred to as ‘junk’. Although there are assets backing the loans, i.e. ‘secured’, their low credit quality still means that there is a greater likelihood of default than a bond with a higher-quality credit rating. The ‘more protection’ can be misleading in this respect.

Where they can offer a greater level of security is when compared to high-yield bonds, which are usually unsecured and have a fixed coupon (rate of interest), and are themselves of low credit quality i.e. they are sub-investment grade or junk bonds; but this does not make them safer than an investment-grade bond. Whilst you should get most, if not all, of your capital back in the event that a secured loan defaults, what you don’t get is the remaining interest payments. Whereas an investment-grade bond is less likely to default, so the interest payments should be more reliable and be paid in full, and this is in addition to getting back your capital.

 

The different types of debt can behave differently to each other with the same set of circumstances. And it is these differences that can allow holding investment-grade bonds to be beneficial to the investor. If you do have an interest in reading more about bonds then the following could be of interest: http://www.pimco.com/EN/Education/Pages/Everythingyouneedtoknowaboutbonds.aspx

 


#9

Bingo, it was Henderson Diversified Income @arkwelder The article is here: http://whichinvestmenttrust.com/henderson-diversified-income-suitably-hedged-inflation/

The tables comparing the different types of debt and the explanation of senior secured debt I found helpful because it’s not in gobbledygook.

Thanks for the Pimco link.


#10

I don’t own any investment trusts though I wanted the Gabelli one but missed it and I have owned Neil Woodfords unit trusts for many years at both Invesco and his new firm and I’m considering his new launch.

I don’t like the fact the price moves up and down and you could get trapped with a discount. I prefer unit trusts as a result but i am open to persuasion or at least open minded.