Investment trusts have many structural advantages from using gearing and smoothing income to investing in private companies. At the final Sub35 webinar of 2021, wealth managers heard how two investment trusts put the structure to good effect.

Unquoted investments
Scottish Mortgage, Baillie Gifford’s flagship investment trust and the largest UK trust with assets of more than £21 billion, is increasingly realising the benefits of investing in unquoted companies. The closed-end structure is ideally suited to illiquid investments such as these.
At the end of October, the portfolio held 50 private companies, accounting for 18.8% of assets.
“We need to take a step back and look at what’s happening in capital markets and focus on one particular area – why are companies staying private for longer?” asked Claire Shaw, an investment specialist on Scottish Mortgage.
Over the last 20 years companies have been listing later, meaning that more value is sitting in the previously overlooked later stages of private markets. In 2006, there was just under $10 billion of value in unicorn companies (private business with a value of more than $1 billion); in 2020, there was more than $2 trillion.
Three factors are at work: firstly, less capital is required to start and grow a business; secondly, listing rules are much more stringent and the cost of being a public company has risen more than five-fold since 2010; and thirdly, founders increasingly realise they can build better businesses by staying private for longer.
“Closed-end structures like Scottish Mortgage are ideally placed to capitalise on this trend. Giving investors liquid access via a listed vehicle to private companies is a distinctive offering in today’s market,” she said.

Income generation
Henderson High Income “utilises the investment trust structure in a very unique way to generate a very high income”, according to David Smith, its manager since 2012. He describes it as “the Ronseal of investment trusts” due to its high and growing income stream and current dividend yield of 6%.
“That’s really important in today’s market,” he said, quoting a statistic that the number of retirees in the UK is set to grow by 50% over the next 20 years. “And they need income. If you look at traditional sources of income – whether that be savings accounts or bonds – you just can’t fulfil that income requirement today, so people have to start looking at different ways of generating that income.”
Investment trusts can build revenue reserves by holding back up to 15% of the income they generate in plentiful years to distribute in leaner years. They are also able to gear (borrow money to invest alongside shareholders’ funds) to enhance returns, both capital and income.
The trust predominantly invests in UK equities but one of its unique features is its ability to own bonds. It has gearing of around 23% at present, which funds the bond portfolio, dampens volatility and augments income.
Over the past decade, investors have received their initial investment back in income – twice the level of income from the FTSE All-Share index. At the same time, there has been good capital growth, too.

To find out more about how the two trusts use the structure, watch the webinar.