Fears over investment trust sales as new disclosure hikes costs


Investment trust sales may come under pressure due to new EU rules, experts have warned. The potential benefits of gearing on investment trusts risk being overlooked as new cost reporting rules make them look more expensive compared with open-ended funds.

Traditionally, closed-ended funds have looked attractive based on lower costs compared with other structures, as well as their longer-term investment horizon and higher liquidity. However, charges in the new Key Information Documents under the recently-launched PRIIPs regulation must include the cost of borrowings, which are not included in the traditional ongoing charges methodology. Other funds such as OEICs cannot use gearing so are unaffected.

Gearing, which is expressed as a percentage figure, is a tool for investment trust managers to borrow money and reinvest it on behalf of shareholders.

Before the new PRIIPs rules, the popular Scottish Mortgage investment trust had an ongoing charge figure of 0.44 per cent but is now showing nominal ongoing costs of 0.84 per cent. Baillie Gifford’s Monks trust previously had an OCF of 0.59 per cent but now has ongoing costs of 0.86 per cent.

Numis head of investment companies research Charles Cade says many advisers are only now including full charges on funds in correspondence with clients, but adds that these look misleading because the cost calculations vary across the industry.

He says: “Gearing is shown as a cost but is often a benefit so you are only showing one side of the equation. This will have an effect on some advisers and impact their choices, especially when the market is weaker. When clients see in pounds and pence what they are paying, that is when they become more cautious.”

Baillie Gifford director of retail marketing and distribution James Budden says it makes “little sense” to treat borrowings as a cost and exclude potential capital or income returns from the assets financed. He says gearing should always be treated as an investment cost rather than an operational cost.

He says: “The upshot of this decision is more confusion and less transparency for the consumer who, when looking at the KID, might think that costs have recently doubled for Scottish Mortgage and Monks when actually they have reduced year on year.”

Analysts have previously noted the lack of consistency in the way costs are calculated in the investment trust sector as some funds include stamp duty, some have excluded finance costs or performance fees and others have “huge differences” in transaction cost estimates.

Cade says: “Some real estate investment trusts produce KIDs and others don’t. In Europe they don’t have to show KIDs, in the UK they do. Guidance is not clear. Some don’t show performance fees, others do. There are also huge differences in transaction costs in private equities, because some underlying costs are not included.”

The FCA decided investment trusts came under the PRIIPs regulation, but advisers warn investors should continue to distinguish the merits of trusts compared with open-ended funds.

According to the AIC, some investment companies have used gearing for 30 years at less than 3 per cent. This resulted in a 3.9 per cent yield if invested in the FTSE All-Share index.

Looking at performance, the average investment company is up 144 per cent in the past 10 years while the average open-ended fund is up 96 per cent over 10 years, according to the trade body.

Meldon & Co managing director Mark Meldon says trusts are a “core” investment to many investors despite being difficult to explain, and thinks comparing costs with open-ended funds is not appropriate.

“The KIDs are an absolute disgrace because they are built on past performance,” Meldon says. “The problem I have is, on the face of it, trusts look more expensive than OEICs. But you are comparing apples and pears. There has been too much time talking about costs. It is absolutely correct talking about it, but you can’t compare the two types of funds. I tend to avoid highly geared funds as they magnify the downside. Income is the key for this. If you have a boring IT tracking new income every quarter and that income keeps rising it is great, while OEICs are more volatile.”

Meldon invests in the OLIM Value and Income trust, which has a mix of commercial real estate and equities and has a 3 per cent ongoing charge.

He says: “The charge sounds very high compared with an index fund, and it is, but the trust has a 20 per cent discount and a very good yield. I measure value by income and not capital growth. Trusts I like have managers that have skin in the game. I also buy research at £3,600 a year form Winterflood. Without it, I am a bit stuck.”


The Association of Investment Companies communication director Annabel Brodie-Smith says it is important advisers recognise that there is a completely different methodology being used for the investment company KID charges and therefore they are not comparable with charges for open-ended funds.

Brodie-Smith says: “It’s true that gearing costs for investment companies are included in the Kid, but this disclosure fails to explain the potential benefits of gearing. Gearing is an advantage of investment companies which has contributed to their strong long-term performance record.”



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