Protecting your cash from the pitfalls of the stock market has not been a problem for much of the past decade, but in 2022 this has been flipped on its head, with the outbreak of war, rampant inflation and higher interest rates making it a difficult time to invest.
UK investors have therefore been seeking out defensive portfolios to protect their savings. Indeed, low-risk trusts have consistently appeared on the most-bought lists among fund platforms so far this year, including at interactive investor, where Capital Gearing has proven a popular option.
Alternative assets meanwhile have dominated the top-performing charts each month as they have provided respite from inflation: arguably the biggest risk to markets at present.
However, one question some investors face is whether to back funds or trusts as each come with their own specific benefits and problems when looking to protect capital. Below Trustnet asked experts for the pros and cons of each when hedging against inflation.
Liquidity
With markets becoming increasingly volatile, some managers have increased allocations to areas that have made gains this year such as energy, infrastructure, debt and property.
But some of these assets are famously illiquid, such as property. In 2020, many property funds were frozen to avoid too many investors pulling their cash out at once, leaving many unable to remove their capital for months after.
Property funds were hit similarly after the Brexit vote and the assets under management (AUM) held by this sector have fallen by £12.9bn between May 2016 and March this year.
When buying units in open-ended funds, investors essentially give their cash to the asset manager. When selling, they simply return the units and receive the new worth.
This causes a problem however when there is a run of selling as the fund is forced to sell assets to meet redemptions. With illiquid assets such as property, this is not easily done and in if withdrawals are too large and the fund does not have enough cash to pay everyone back, it may need to shut to sell enough assets to meet redemptions.
This is not a problem that investment trusts have. Here, the company issues shares at a set price, collecting the money. Then investors trade these amongst one another, with the price fluctuating.
This means the amount of money that the company has to invest never changes and therefore it is not a forced seller.
Kelly Prior, investment manager at BMO Global Asset Management (EMEA), can select between trusts and funds in her portfolios.
She said that she prefers funds in general, but accepts there are some areas that investment trusts are better suited to, such as illiquid assets.
Prior added: “Twenty Four Income, for example, invests in asset-backed securities, loans and the like which are all virtually zero rate exposed [so will combat inflation], but are also illiquid and therefore more suited to this structure.”
Exposure to alternatives
Vincent Ropers, portfolio manager at Wise Funds, said that the fixed pool of capital available to trusts make alternative investments more accessible.
It is easier and more reliable for investors to sell-out of trusts that hold alternatives and he therefore allocates about 60-70% of his portfolios to investment companies.
Ropers added: “It is a great tool ready to offer diversification and to get access to strategies that are more niche than you would find in an open-ended format.”
Around 170 trusts have launched since 2008 (more than 40% of all investment companies) and 70% of them provide exposure to alternatives, according to Simon Elliott, head of investment trust research at Winterflood.
James Sullivan, head of partnerships at Tyndall Investment Management, said that many alternatives had “inflation linkage baked into their revenues”, which made them attractive when costs are rising.
However, he added: “There is no rule book which states the right or wrong structure; it’s more a case of what appeals to the investor at a moment in time paired with cost and platform consideration.”
Diversification
Sullivan said that while access to illiquid assets through fixed capital is an appealing trait of some trusts, they do not offer enough incentive to make them a better option to funds.
He added: “Where an investment trust does the same job as a similar fund in the open-ended space, it’s fast becoming an irrelevance.
“It must be offering something the open-ended community cannot if it is to survive and grow. It must take advantage of its fixed pool of capital.”
Prior added that funds tend to benefit from more diversification in their underlying holdings and assets are less likely to be impacted equally by market movements.
She said: “Volatility can be your friend or your foe, but rarely is it a good thing in terms of pricing for closed or open-ended vehicles.
“Spreads on prices tend to widen in times of volatility, so for open-ended vehicles this will be born through the underlying holdings, with trusts the price will widen.”