How much can you like a company?

I don’t generally comment on investment trusts (ITs) as they are listed shares with different risk characteristics to open ended funds (OEICs), but they are a form of collective investment and some argue they are a cheaper way to access a fund manager’s skills. That assumption is not based on a general reality, but on some selective observations of certain trusts.

I looked at the Lindsell Train IT recently because it came to my notice while I was researching the Japan OEIC covered in my monthly subscriber newsletter. It is a great example of people taking a really big bet and quite likely not knowing what they are doing!

The shares in the trust are at an astonishing 100% premium to the asset valuation! That means people are paying twice as much to buy a block of assets via this trust than they would pay if they just went and bought the same assets directly. They can only be doing that because one key asset is the Lindsell Train business, whose shares you just can’t acquire in the ordinary market.

I had to check and re-check that – it was so remarkable. The fund is 100% geared, so has borrowed against the security of the investments such that if it was wound up in severe difficulty, the shareholders would get nothing (or a very small payout). The banks would probably be able to take all the assets.

Worse than that, a sharp fall in markets would likely trigger covenants in the bank lending agreements that would require loan repayments, making the trust a forced seller of shares in a falling market. Did the word Woodford pop up in your mind?

The dividend yield is well below that of the main shareholdings, at 1%. So no-one is buying this fund for income.

Notably, almost half the trust is invested in the unlisted Lindsell Train company. That would be impossible with an OEIC and is one of the reasons I stress that investment trusts are NOT to be seen as having the same risk profile as OEICS.

In short investors, one might say, admittedly as a simplification, have invested in a trust the assets of which have been fully mortgaged to buy shares in the manager’s company! That strikes me as demonstrating huge enthusiasm for the Lindsell train business – in effect giving it an interest free loan in the hope that its shares will rocket in value.

Maybe they will – but do the bulk of small investors (a lot of share trades are in amounts of just a few thousands) actually understand the proposition? I hope so.