Is Your Investment Advisor Holding Back On Recommending Investment Trusts?

A study carried out by Research in Finance, a market research and consultancy business specialised in financial services, indicates that leading British investment advisors are holding back on recommending investment trusts to their clients. That’s despite the fact that they routinely outperform the unit trusts they do recommend.

Unit trusts and investment trusts are two alternative fund structures. Unit trusts are open ended funds. That means when they attract more investors, the capital under the fund’s management grows and is used to purchase more of the same assets the trust is already invested in.

In the case of investment trusts, the capital under management is fixed at the outset and its value only changes as a result of the performance of its investments. Investors buy units in the trust, which are then traded over a stock exchange like company shares. That means if the fund is popular, the value of those units can be more than the underlying value of the assets held. It also means they can potentially trade at a price that is lower than the value of the underlying assets.

The advantage of investment trusts is that they are not forced into selling off assets if more investors chose to cash out their investments than the value of the cash reserves the fund holds. That’s the scenario that has led to several high profile unit trust-model funds being forced to suspend withdrawals in recent years.

A number of property funds operated on a unit trust model were forced to suspend trading after the Brexit referendum result and again early this year. It’s also why the Woodford Equity fund was suspended last year before it was eventually closed down.

Unit trusts have traditionally been far more popular with advisors than investment trusts as they used to earn commission from the fund companies running them when their clients bought in. That model was banned, considered a conflict of interests, by the 2013 introduction of the Retail Distribution Review.

The move was designed to ‘level the playing field’ and mean financial advisors had no incentive to nudge clients towards unit rather than investment trusts. In theory, they would recommend whichever looked like the best option for the client. But the Research in Finance research found that despite the change in rules around commissions, many large advisors, including Hargreaves Lansdown, Openwork, St. James’s Place and Chase de Vere still very rarely recommend them. That’s despite the fact that investment trusts have shown superior performance.

When asked for comment on why that is the case, the companies responded as follows:

St James’s Place: “Our clients invest in specially tailored portfolios of open-ended funds.”

Chase de Vere: “We do occasionally recommend investment trusts, but have to balance their extra volatility and price fluctuations”.

Hargreaves Lansdown: “We don’t provide advice to clients on investing in investment trusts primarily due to liquidity concerns and extra layers of complexity.”

Openwork: “We find the unit trust model more flexible and it is easier to switch funds.”

The reasoning provided by the investment advisors asked for comment doesn’t quite seem to equate with the historical performance data between the two fund models. Nor the fact that it is unit trusts that have struggled with well-publicised liquidity issues in recent years.

One downside to investment trusts is that their exchange traded value can underperform underlying asset value during bear markets. But that also opens up investment opportunities. Long term investors can seize the opportunity to invest at prices below underlying asset value, taking advantage of often strong returns when market sentiment turns positive again.