Thematic Investing through Trusts


Investing in investment trusts carries a number of benefits such as diversification and harnessing the knowledge of the respective trust managers. However, given that investing in the 'Equity Investment Instruments' sector is not widely understood or followed, it's important to understand what benefits they can bring to a portfolio. One of the standout benefits of trusts is that they are excellent for thematic investing; that is investing in certain themes such as macroeconomic themes and sector-specific themes. This tutorial will look at a few recent examples of themes you could have followed of exposure to certain areas that you could have targeted through investing in specific trusts.

Theme 1: Riding the Japanese rise

Valid as of 27/05/15
This first theme looks at the Japanese stock market and in particular the Nikkei 225 is a stock index that is a good reflection of the overall movement. As a result of a range of macroeconomic factors including quantitative easing, the Japanese market has been showing strong growth. In fact, you can see that since January 2015 alone the Nikkei 225 index has advanced by circa 17.4%, outpacing most of the stock markets of western developed economies. Figure valid as of 27/05/15.

Perhaps you sought to take advantage of the strong market conditions in Japan in January 2015; what options from a UK platform do you have? In reality, there is not much you can do on the London Stock Exchange on the companies side since very few have major operating bases in Japan. Another option would be to invest in Japanese companies, but this can be a costly and tricky process in terms of translating all of the financial information into £ GBP, for example, and you may want to track your holdings' price movements which may be awkward and time consuming given the time zone different. A further option would be to simply buy a Nikkei tracker fund; this is a viable option although again the time zones do not align nicely.

An attractive option would have been to identify and purchase shares in one of the UK investment trusts that is invested on Japan. To show the range of options available, I have quickly identified 5 trusts that focus on investing in listed Japanese companies.

The above table shows that four trusts saw growth above that of the Nikkei. The clear benefit of investing in these trusts is that the time difference issue is gone with these trusts trading as per the hours of the London Stock Exchange. Furthermore, these trusts provide you with sufficient diversification across many different Japanese companies and are largely selected by a fund manager with many years relevant experience. They essentially give you exposure to Japanese stocks via a London portal.

The potential downside of these trusts versus a tracker fund is that not all of these trusts did outperform the Nikkei over that period, with the Aberdeen Japan Investment Trust clearly underperforming. I'll cover potential drawbacks of investing in these trusts versus tracker funds in a future tutorial

Theme 2: Playing the Biotech Boom

Valid as of 28/05/15
A further theme that has come to fruition in 2015 is that of rapid share price growth in many of the pharmaceuticals and particularly biotechnology stocks. However, that growth has mainly been felt towards the smaller end of the market cap spectrum and not so much with major companies such as AstraZeneca (LSE:AZN) and GlaxoSmithKline (LSE:GSK). The chart above shows the movement of the FTSE 350 Pharmaceuticals & Biotechnology index over the past year. Year-to-date the index is up approximately 6.4%. Figure valid as of 28/05/15.

Finding a index tracker fund for the high growth prospects is consequently not necessarily the best way of playing the biotech boom. A better way would have been to invest in one of the smaller trusts such as the three below, that seek out targeted exposure to the sector through what they feel are the best companies to invest in.

Over the same period, each of these trusts has significantly outperformed the wider index, and comfortably so even when factoring in their respective spreads. Why is investing in these trusts superior to individual stock picking? Well, first and foremost, investing in the biotechnology and pharmaceuticals sector at the smaller market cap range requires sound knowledge of both the science and the market competition. Given the complexity of the science involved, it can be daunting to invest in the sector and there is a high risk level in some of the smaller firms who are perhaps reliant on just a few scientific concepts.

These trusts give you immediate diversification across companies, but more importantly you get the experience of the respective trust managers. These managers often have decades of experience either in the industry, or investing in the industry.

Furthermore, in the case of International Biotechnology Trust, you get investments in companies beyond the UK (90% are actually US and Canadian companies), and you also get companies that are unquoted. So there is flexibility in terms of what each investment trust offers.

Theme 3: Searching for Small Caps

Suppose that you wanted exposure to mid and low tier companies rather than exposure to the largest multinationals such as Tesco, but you do not want to have to worry about specific stock selection. You may want this theme for your portfolio is you believe that the smaller companies are likely to be internationally scaled and are so a better play on the UK economy.

Valid as of 28/05/15
The above chart for the FTSE250 index shows that the index has risen by around 13.5% year-to-date. Purchasing a tracker fund would have given a similar return, but how does that compare to five randomly chosen more specific UK small cap trusts? Remember that these trusts have had their investments headed up by a manager.

The above table shows that 3-of-5 investment trusts have outperformed the FTSE250 with the other two underperforming by about 1%. However, had you invested an equal amount of cash into each of these, you would have achieved an average gain of 16.7%, comfortably above the 13.5% that the tracker fund would have achieved.

However, that gain would have been trimmed by various spreads and commissions hence it does not make sense to purchase a basket of investment trusts over a sole tracker index.

Nonetheless, this range of trusts shows just a handful of small cap trusts that are on offer to investors and they can simplify the investing process as well as enabling you to leverage the experience of the trust manager. That said, there is a significant deviation in returns between the trusts hence it's important to be able to identify which one has the greatest potential and look at the past track record of each manager.

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