22 Nov 2011 | Opinion

Diary of an Investor Part 3 - Reflections 

Private investor Charles White reflects on his
past investment experience.
 

In previous articles I described how I have built up a portfolio of investment trusts through long-term monthly savings in a core of established trusts, mixed with medium-term investments in some riskier or more specialist trusts. Here I conclude with some reflections on that experience.

Over this period I have experienced a number of market ups and downs – from the dot com bubble and war in Iraq to the continuing aftermath of the 2008/09 crunch. Trust share prices followed the down trends and some extended losses compared to indexes, reflecting a widening discount, or the effect of gearing (borrowings made to fund purchases). These events are a reminder that for any form of equity investment, while buying is easy, deciding to sell (or not!) is more difficult. At such points I look back to my original motivation for equity investment and whether I have a compelling need to sell to raise cash. My long-term view has remained positive to equities (no event yet being financial Armageddon) and therefore a price recovery should come. It certainly tested the “don’t invest what you cannot afford to lose” approach, and while there was a loss on paper the cash I had retained or realized in regular reviews made that manageable and I did not feel compelled to sell. So for the long-term monthly savings I held on and continued to invest, viewing the downturn as opportunity.

From the 2008/09 downturn most of the trusts have recovered to the pre-crunch levels and performed well in early stages of recovery – narrowing of discounts, the positive effect of gearing and active fund management contributing to swift recovery. One advantage of investment trusts as ‘closed end’ funds is that the manager can follow a particular investment approach through thick and thin without being forced to sell shares at a loss to repay investors wanting to cash-in. So my continued monthly investment paid off. Indeed a lesson from the volatility perhaps is that monthly saving schemes reinforce the discipline to stay invested and avoid the temptation to sell unnecessarily as they do not offer instant trading.

I have also come to appreciate that while my investment goals were growth rather than income, dividends too can be a substantial growth contributor with relatively low risk, as well as mitigating the effects of downturns (one further reason not to panic sell and miss the dividend reinvestments). Investment trusts do not have to distribute all income from the portfolio as dividends to shareholders, and many actively retain some income from good years to ensure a dividend is at least maintained during leaner times.

Several trusts, mainly with a UK focus, adopt this approach and offer sustainable yields of 4 – 5%. For example, looking back over 20 years’ of investments in Edinburgh Investment Trust, I had invested in the trust’s monthly scheme for some 10 years up to 2003, at which point I switched to investing via an ISA instead, but kept the original scheme funds as well. Over the 6 years to 2009 I made no further contribution, yet the number of shares held increased by 25% through dividends reinvested. Share price performance between 2003-2009 was not great (both were dip years between a peak) but the effect of the increased shareholding gave a respectable return, and continues to leverage my original contributions. In recent years I have actively adopted this approach, switching most of the Edinburgh holdings to an ISA and adding a number of other high-yielding UK trusts, to give a good dividend stream to reinvest and some smoothing of ups and downs.

A perennial topic for investment trusts is the discount (or sometimes premium) that the share price stands to the portfolio net asset value (NAV). This is sometimes represented as a ‘bargain’ argument: spend £1 on an investment trust share with a 20% discount and get £1.20 assets – but that’s only realised if and when the discount reduces. I don’t have a general theory for the discount, though it can be seen as a measure of investor sentiment toward the trust and perceived risks in its assets, structure or management. I have found changes in a trust’s discount away from its trend or usual range, or how it compares to similar trusts, can be a useful indicator for timing sales or top-up purchases, perhaps as a contrary view to investor sentiment. One word of warning however: large trusts investing in equities typically provide a daily NAV figure from which discount is derived; but trusts that depend on subjective valuation methods (e.g. property, private equity) may only publish monthly or even quarterly NAVs, which can result in sudden sharp movements - the NAV shown in between times is usually an estimate.

Over time the range and availability of investment trusts has changed as the appeal to retail investors, especially low costs, has been recognised through the press and more active advertising by trusts themselves. Upcoming changes by the regulator on payment of commissions to advisors which has favoured unit trusts could increase appeal and visibility of investment trusts, which if it raises demand may well reduce discounts. I have seen individual trusts change too, illustrating one of the features of investment trusts as independent companies with the ability to change investment direction, name and fund management company employed if they need to get better performance.

I currently have holdings in 17 trusts, ranging from major international equity market sectors, to more specialised trusts focused in private equity, technology, property, bonds, commodities and environmental themes. Investment trusts remain my preferred vehicle for equity investment, as pooled funds with low costs, flexibility and independent management. I will also be sticking to a balanced and long-term approach and realising some profits periodically. While this may not make the most of potential high-growth short-term opportunities (it’s easy to be tempted to overreach during the good times and I have in the past as often lost as gained in that way), it offers growth with an acceptable level of risk and protection for me in the current markets.

And finally I have also been investing for my two children through the Baillie Gifford Children’s Savings Plan, choosing the Scottish Mortgage Investment Trust, for its broad international approach, and the Pacific Horizon Investment Trust for an additional eastern focus which I believe will be ever more important for their generation and outlook - my youngest son has taken up Mandarin as a school subject. Dividends will of course be reinvested.

Please remember that the value of a stock market investment and any income from it can fall as well as rise and investors may not get back the amount invested. Investments with exposure to overseas securities can be affected by changing stock market conditions and currency exchange rates.

The views that are expressed in this article should not be taken as fact and no reliance should be placed upon these when making investment decisions. They should not be considered as advice or a recommendation to buy, sell or hold a particular investment. Past performance is not a guide to future performance.

This article contains information and opinion on investments that does not constitute independent investment research and is, therefore, not subject to the protections afforded to independent research.

STANDARDISED PAST PERFORMANCE
Edinburgh Investment Trust plc

Author: Charles White
Charles White is a private investor.