Permanent capital may sound like a technical advantage of investment trusts but it is never more important than when coping with the extreme volatility of emerging markets.
Unlike unit trusts and open-ended investment companies (Oeics), closed-end funds such as investment trusts do not need to sell assets at low prices when confidence wanes or a sector falls from popularity. Instead, investment trusts can allow their share price to take the strain.
That means speculators who bale out during downturns will bear the brunt of their short-termism without forcing long-term investors to subsidise them as they turn paper losses into real ones.
By contrast, short of suspending trading – as can happen in extreme slumps – unit trust and Oeic managers must sell at whatever price they can get to meet redemptions, which is bad news for long-term investors.
Never mind the theory, though, this has worked well for me in practice over more than a decade as a shareholder in what used to be Pictet Emerging Europe investment trust and is now BlackRock Emerging Europe (BEEP). Despite recent political shocks in Russia and Turkey, the shares have risen by 42% over the last year.
Half the underlying assets are invested in Russia and nearly a fifth in Turkey. No wonder the shares trade at a discount to net asset value (NAV) but perhaps the real surprise is that the discount to NAV is currently only 8%.
Less surprisingly, it’s been a bumpy ride before this trust reached the sunlit uplands. Last year the shares fell by 4%, having slipped 2% lower during the previous 12 months after falling by 12% during the previous year.
During those difficult days it was a major comfort to this long-term investor to know that co-managers Sam Vecht and Chris Colunga would not be forced to try to turn top holdings Sberbank or energy giants Gazprom and Lukoil into cash at any price.
Investors in emerging markets unit trusts had no such structural support and, instead, faced a kind of prisoner’s dilemma. Why hang on in hope when you don’t know how others will react to a crisis? There is no point being last to the exit in an open-ended fund.
Of course, there is no guarantee that any of these investments will reach a happy ending – least of all because most emerging markets have been emerging markets before. More than 30 years ago, when I was a cub reporter on Fleet Street, the very first financial feature I wrote concerned a reader who had found a sea chest full of Czarist Russian bonds.
His grandfather had been a raging bull of what looked like the hottest emerging market in the world before the Russian revolutions of 1917 rendered this paper worthless. The reader had only got in touch because Mikhail Gorbachev, Russian president at that time, was offering a few pennies in the pound to redeem these busted bonds.
In the end the reader raised more cash by selling to ‘scripophily’ enthusiasts who collected them as a kind of cautionary art. Back in those distant days, stock brokers often displayed busted bonds on their office walls.
Perhaps, after the recent bull run, we could do with similar visual warnings now. Presidents Recep Tayyip Erdogan and Vladimir Putin are both controversial figures, raising serous questions about whether it is possible to be an ethical investor in emerging markets. But this week’s surprise announcement of a snap general election in Britain should remind us that political risk and investment opportunities do not begin or end at Dover.
Next month Jupiter Asset Management will launch a new emerging markets investment trust in the belief that this is the best way to cope with systemic risk. Jupiter Emerging & Frontiers Income Trust will not be fire-proof but at least its closed-end structure will offer some degree of security in the most volatile markets in the world.
Full disclosure: here is a complete list of Ian Cowie’s stock market investments. It is not financial advice nor is any recommendation implied.