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With things looking grim at home and in the US it’s time to expand your horizons and try investment trusts. Timon Day packs his bags and heads to the emerging markets where business is booming

Investors have taken a bruising so far this year thanks to a 2008 slump that has hit UK share prices across the board. The FTSE 100 is down almost 9% since closing 2007 at 6,456.9, and at its worst, earlier this month, showed a 11.6% decline, a dramatic fall given the new year is barely seven weeks old.

Yet glance beyond the boundaries of our own market and the you will find investment weather that is a good deal more clement. Some of the world’s most exciting growth markets remain just that, exciting and growing. From boom time in Brazil to the rampant rise of the Russian market, India to Egypt, China to Chile, a number of emerging markets around the world look more than capable to posting impressive returns in the coming weeks and months.

Yet tapping into this potential can be easier said than done for the average private investor. Research remains thin on the ground in many cases, even in spite of the tools and facilities to be found online, making it trickier than ever to identify individual stocks worthy of your cash. And even if you do pinpoint a potential investment, actually buying the shares can still be difficult because few UK-based brokers can really offer in-depth access to many emerging markets. So what do you do?

The answer is investment trusts. These collective investment vehicles come with the access and expertise few private investors are able to match thanks to specialised knowledge in particular regions, often built up over years of experience. Plus, they also offer a broadly based investment philosophy that neatly spreads the risks inherent in these far-flung markets.

Built to perform

Investment trusts have a far better performance record than many other collective vehicles, such as unit trusts, and they also offer monthly investment schemes, where you can drip-feed your contributions over a prolonged period of time.

This is an attractive option for investors with little local market expertise in obscure parts of the world such as Latin America, Asia or Africa for example. In essence you are paying the fund manager to make sound investments in a particular region on your behalf on the basis of their in-depth knowledge of a market that you lack. It is a lower risk way of investing in a higher risk market, or in other words, it opens the door to opportunities that many investors would otherwise avoid.

Investment trusts are also much better value than they were. Most trade at discounts to their net assets, in some cases by as much as 20%. While part of that discount is a reflection of the management fees that investors must pay for the privilege of a fund’s experience, expertise and access, this doesn’t necessarily explain why the valuation gap is so wide in many cases. This disparity means that the value of the shares owned by an investment trust often far exceeds their market value, sometimes by a significant margin, and this provides the potential for investors to cash in on a profit-making double whammy as net assets increase and the discount narrows.

Many market experts see plenty of promise overseas, and in using investment trusts to tap this rich vein of potential. Mark Dampier of Hargreaves Lansdowne says investment trusts are the best way to invest in emerging markets. His favourite countries are India and Vietnam.

‘India is insulated from the world economy with only 15% of its GDP reliant on exports,’ says Dampier. However, the Indian stock market has doubled in the last two years, putting it on a demanding prospective PER of almost 22. The Chinese market has done even better and shares look overvalued on a PE of around 35.

But those taking a long-term view should do well. Smart investment managers like Agnes Deng, manager of the Baring Hong Kong China Fund, is overweight in companies she thinks will benefit from the ongoing infrastructure development and telecommunications. She is more cautious about exporters, preferring those likely to benefit from rising domestic consumer spending.

From Russia with love

Russia could carry on performing though its shares are no longer much more lowly rated than Western markets. JP Morgan Russian Securities is an excellent way in with superb short and long-term performance figures. It is second in both the one and ten year tables, and third over a five year period.

Russia has embraced capitalism and there is no turning back. Admittedly it is the state-controlled sort of capitalism with the government taking controlling stakes in the top 100 companies.

This has not stopped the market rising seven fold since 2000. But investors should remember that around half the companies listed are either oil, gas or mining so there is a big bias.

Baring Emerging Europe has a good track record, too, investing in many of the Eastern European ex-Communist countries.

JP Morgan scores well again with its Indian investment trust which is the top performer over five years, fourth over ten and eighth in 2007. Fidelity Asian Values had a good 2007 with a 44% rise but is less impressive over the longer term.

For those wanting a broader brush the best bet might be a pan-Pacific rim investment trust or a Latin American trust.

Merrill Lynch’s Latin American has performed well over one and five years with a 42% and 644% return respectively but only managed 354% over the last decade. Brazil looks one of the best of the BRIC bets with strong internal growth and a wider based economy buoyed by a rapidly growing number of house buyers.

Pacific Assets came sixth in 2007 with a 49% share price rise and was about 50% better than the average investment trust over five years but returned only 171% over ten years against the average investment trust performance of 154% for that period.

New kid on the block Utilico Emerging Markets is one to watch with an excellent 49% advance last year. Just ahead was Templeton Emerging Markets, which did particularly well with a 50% jump in its share price in 2007 and 388% over five years which falls to 332% over ten years.

Choosing trusts by country and regional performance is not necessarily the best way though.

A star performer last year was F&C Private Equity A with a stunning doubling of its price. It also came sixth in the five year table.

Will private equity funds perform as well over the next few years? Without the benefit of a crystal ball one might say the chances have fallen for several reasons. One is that they are biggest in developed countries where stock markets might find it tough to make much headway over the next year or two.

Second there are now over 10,000 competitors all fighting to grab the best deals. Lastly there is a lot less cash available in the wake of the credit crunch so cheap finance can no longer prime the pumps making deals more expensive.

Time to trust

Another route to consider is to plough your money into commodities or mining. Merrill Lynch had done well with its new Commodities Income investment trust with a 51% rise in 2007. Its World Mining vehicle has proven pedigree over one, five and ten years. Resources Investment Trust was close behind last year and just ahead over five years. While past performance is not a reliable guide to the future it should certainly be respected.

Yet another alternative is to look at trusts that invest in other trusts, referred to as multi-manager funds. These reduce risk even further though a wholesale market slump will still see them fall.

Richard Philbin, co-manager of F&C Investments billion pound multi-manager fund range, reckons they are the best for portfolio diversification. ‘Now, more than ever, is a time to look to the long term and not to put all of your eggs in one basket.’

Managers of multi-manager funds conduct a high level of fund research and usually have access to a large number of fund managers unavailable to private investors. Investors benefit from their expertise in portfolio construction and you don’t have to constantly monitor what is happening, as this is all done for you.

There are two types of multi-manager fund: Manager of managers and fund of funds.

Manager of manager funds invest in stocks and shares through appointed investment managers. This means they can tailor funds to suit their requirements, risk profile and management style.

He who dares

Investors that make the most money tend to be willing to take more of a gamble, buying in to sectors or markets that look too cheap on hopes of a sharp recovery.

So maybe UK smaller companies could be the place to be. After all Gresham House (GHE) is the top performing investment trust over ten years with an outstanding 3,680% performance. The problem is the tail off over the last five years with just 13% last year.

This was still much better than most funds and stock pickers and small companies look increasingly good value today.

The other place never to forget is America. The market is taking a bit of a bashing as a recession seems increasingly likely, but those wanting to write off the US should think again. There is little doubt American managers and companies are some of the best performers world wide and a ten or 20 year investment in them via a well managed trust like North Atlantic Smaller Companies, ninth best performer over the last 20 years, could prove a smart move.

Investment trust outperformance

Investment trusts have wiped the floor in the medium and long term performance tables compared to unit trusts and open-ended investment companies (OEICs) over the past ten, five and three years.

In the past decade the average global growth fund has returned 76% while the average global growth investment trust has done twice as well, with a 149% return.

The average UK all share fund managed an 84% growth over the last ten years compared to the 139% return scored by its investment trust counterpart. The same performance gap is true for three and five year periods as well. On average, a global growth investment trust averaged a 121% return over the last five years, compared to a return of only 78% by an average unit trust or OEIC.

Shares readers love investment trusts

Over a quarter of Shares readers own shares in an investment trust and almost 80% invest in three or more trusts.*

You guys are smart with portfolio allocation and risk assessment. You love having a punt on high risk mining or IT stocks. That’s because most of your money is more conservatively invested in blue chip shares and investment trusts plus the occasional unit trust.

* Figures from the Shares Magazine readership survey conducted in April 2006

Wealth Warning

The value of your investment trust can sink dramatically if a star manager is poached by a rival group. So keep your eye on the key talent and if someone like Anthony Boulton has achieved star performance for 20 years and is departing you should think about departing, too.

Investment trust roadshows

The Association of Investment Companies is hosting a series of six free private investor roadshows starting with London on the 20 February. It then moves to Leeds on the 22 April followed by Falkirk on 11 June, Bristol on 17 September, Nottingham on 15 October and ends at Eastbourne on 12 November.

A panel of experts will answer questions such as those raised in this article. What are the best growth areas or are investment trusts an endangered species?

Lunch and refreshments will be served.

To reserve your place email eventsteam@theaic.co.uk or call 0207 282 5564.

What to buy

1 Stocks of developing countries rose 32% on an annualised basis during the past five years, making emerging-market stocks the best-performing investment category over that time. However, emerging-market stocks traditionally have had a volatile history of performance, punctuated by cycles that moved violently from boom to bust and back again.

2 However, there is an idea that US markets will no longer lead other markets. The correlation between 2005-2007 between US and other developed markets was 0.63 according to ING Asset. This had fallen from 0.93 between 2003-2005 when all markets were practically joined at the hip.

But is this true of the BRIC countries on whose young shoulders so much hope rests? Probably not yet as exports from these countries to America and Europe are crucial. It might take another five to ten years for true decoupling.

3 Emerging markets offer the best hope for investors as that is where the fastest growing companies are based.

Time to buy

Investors are shying away from collective investment funds worried as they are about the stock market slump and credit crunch. There was a record £844 million withdrawn from equity funds in December and the January figure might be even worse. Sales of all types of unit trusts exceeded purchases by £377 million compared to a positive inflow of £1.7 billion for December 2006.

Happily for Shares’s savvy readers this could prove a buy signal. Retail investors have an unerring habit of buying near the top and selling near the bottom. For instance during the last bear market from 2000-2003 unit trust sales fell by two thirds and did not recover until the bull market was in full swing in 2006.

Mind you, timing is everything and it would be silly to invest all your spare cash now. The best way is to set up a monthly purchase plan, way of drip-feeding your money into an investment trust. Investment trusts have a far better performance record than unit trusts and also offer monthly investment schemes.

Charges

One reason for the investment trust outperformance is they generally charge much lower management fees, though there is an increasing number charging extra if trust growth meets certain targets. Buying an investment trust is just like buying any other share. You pay a broker’s commission and half a percent stamp duty and there is a small spread between the buy-sell price.

Most funds charge an upfront fee of 3-5% plus annual charges of 1.5% to 2%. There is no discount (or premium to the underlying value of the investments) but it can prove difficult to sell if the market is crashing.

These charges look small but when rolled up they are onerous as the average UK stock market gain (if dividends are re-invested) is 7.1% a year over the last 50 years and only 4.9% a year over the last decade, according to the latest Barclays Capital Equity Gilt Study. Investment trust management charges are around 0.5% a year or 10% of the average equity return in the last decade compared to over 30% for a unit trust.

Shares Six Investment Trust Picks

JP Morgan Russian Securities (JRS) 653p

A wonderfully consistent performer that should carry on delivering unless you think oil and metals are going to crash. Managed by JP Morgan Asset Management.

Top 10 Holdings:

Sberbank Rossii

Mechel

Open Investments

Norilsk Nickel

Unified Energy System of Russia

Severstal Auto

Cherepovets Severstal

Pharmacy Chain

Aeroflot

Magnitogorsk Iron & Steel Works

Outlook

Russian market has performed extremely well since the launch and stock market valuations no longer much below those in comparable emerging markets. As such, future performance reliant on stock selection and Russia’s ability to provide a corporate friendly environment. Weaknesses in legal structure and efficiency of state-controlled companies need to be addressed. However, economy is set on a sustainable path towards higher living standards making market an attractive if volatile investment over medium term.

JP Morgan Indian (JII) 433p

Admittedly this trust only marginally outperformed its benchmark the MSCI India Index last year. Also the return to shareholders was five percentage points lower at 44% as the discount to NAV doubled to over 7%. Managed by JP Morgan Asset Management including a couple of natives.

Top 10 Holdings:

Reliance Industries

Icici Bank

Larsen & Toubro

Bharat Heavy Electricals

Housing Development Finance

Bharti Airtel

Infosys Technologies

Kotak Mahindra Bank

HDFC Bank

State Bank of India

Outlook

Remain positive about India despite spectacular performance since 2003. Believes economy can grow at around 8% pa for next three to five years driven by rising infrastructure spending and growing level of consumption as a result of increased income levels.

Government plans $500 billion investment in to infrastructure by 2013 or 2.5 times as much as previous five years. Markets look quite fully valued at present with 21-23 PE rating for 2008 and 18 for 2009 based on current earnings estimates. So period of consolidation quite likely especially if US recession. Managers prefer sectors dependent on infrastructure spending and consumption such as industrials, financials, telecoms and utilities.

Merrill Lynch Latin American (MLLA) 510p

Great performance over the last five years. Prospects look solid for next five years though unlikely to equal 644% record from 2003-2007. Managed by Blackrock Investment Management which is entitled to performance fee of 10% for any outperformance of the NAV per share over the MSCI Emerging Markets Latin American Index plus a hurdle of 1%. Concentration on Brazil which is going great guns with a 31% appreciation of investments there in the first half helped by the appreciation of the Real versus the $.

Top 10 Holdings:

Cia Vale Rio Doce – the huge Brazilian mining company planning to buy Xstrata

American Movil – Latin America’s top wireless communications provider

Petroleo Brasileiro – usually known as Petrobas it is one of the

most attractive energy stocks worldwide

Banco Bradesco – Brazil’s leading private sector bank

Usiminas – Brazil’s largest steel producer

Ambev Cia de Bebidas – top beverage company

Grupo Televisa – Mexico’s leading broadcaster

Cemex – world’s third largest cement producer HQ Mexico

Unibanco – third largest private bank in Brazil

All America Latina Logistica – Brazil’s biggest railway operator

Outlook

Blackrock reckons LA and Brazil in particular remain most attractive equity markets in world with low double digit PE ratings and mid-teens % EPS growth this year.

Merrill Lynch World Mining Trust (MLW) 616p

This investment trust has capitalised on the mining and commodity boom better than most of its rivals. Also managed by Blackrock.

Top 10 Holdings:

Company Region of Risk

Alcoa USA

Anglo American Global

BHP Billiton Global

First Quantum Minerals Zambia

Impala Platinum South Africa

Minas Buenaventura Latin America

Rio Tinto Global

Teck Cominco Canada

Vale Latin America

Zinifex Australasia

Plans to increase gold exposure from 6% to maybe 10% as expects further rise in bullion.

Outlook

Managers warn that this is a volatile market but optimism for sector remains in place based on sustained demand from China and India. The sector re-rating is expected to continue as supply and demand fundamentals in metals and minerals remain favourable. Also strong cash generation means lots of M&A activity expected, ie Rio Tinto and Xstrata, which will support share prices.

Pacific Horizon (PHI) 152p

The shares have fallen back a quarter from their recent 12-month high after rocketing 70% in the first half of the year. So the premium to NAV has vanished, replaced by a more normal discount of around 10%. They look solid value with a good track record over five and ten years. Managers are Baillie Gifford. Over a third of the money is invested in Hong Kong and China followed by Korea, Singapore and Taiwan.

Top 10 Holdings:

Samsung Corporation

Singapore Exchange

CNPC Hong Kong

Pacific Basin Shipping

China Infrastructure

Machinery Holdings

Bakrie and Brothers

Petrochina

Li & Fung

Hong Kong Exchanges and Clearing

Outlook

Short-term uncertainty expected as markets want to see impact of problems in the global credit markets on real economic activity. Long-term outlook remains favourable.

The Egypt Trust (EGP) US$43.13

This is a left of field recommendation as investing in Egypt might be considered rather foolhardy. Also the Egypt Trust is not strictly an investment trust though you would be hard pushed to tell the difference.

Egypt is doing rather well on the PDQ. Peace with its powerful neighbour Israel, financial support from Uncle Sam and a stable, if highly autocratic President, have combined to generate real economic growth buoyed by finds of oil and gas. Anyway, £100 invested in the Egypt Trust five years ago is now worth £706 and it grew 48% in 2007. This was achieved in spite of big volatility on the Cairo and Alexandria exchanges.

Egypt offers a solid emerging market story with its large population, structural reforms and GDP growth of 7%. The long term challenge is to increase employment and living standards of the poor. Managed by Lazard Asset Management.

Top 10 Holdings:

Orascom Construction Industries

Telecom Egypt

Orascom Telecom Holding

Commercial International Bank

National Societe Generale Bank

Orascom Hotels and Development

Egyptian International Pharma Investment

Egyptian Financial & Industrial Co

Heliopolis Housing & Development

Alexandria Mineral Oils

Outlook

Lazards reckon Egypt is on the ‘right track’ and the stock markets have grown more robust. Admittedly valuations are now close to other emerging markets so stock selection is the key. Corporate earnings could surprise on the upside especially in the medium cap segment. Lazards are less optimistic about large cap prospects as they might be overvalued.