How do you deal investment funds that are showing a loss on original purchase price?

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We are pleased to provide a guest blog from Rabix Wealth who understand the importance of psychological  differences with a variety of investors.

Investments, particularly in equities are subject to capital fluctuation or variances (most investors regard this as profit or loss)  – ranging from 30% for generalist unit trusts to 50% or more if invested in specialist area, including resource stocks and or investment trusts. However a capital variance only becomes a profit or loss when one sells an investment.

How you cope with capital variances depends upon the type of investor  are:-

DIY – DO IT YOURSELF INVESTORS

Typically we find that investor’s who manage their own portfolios, will hang onto loss making investments in the hope that they will recover. Instead of selling the problematic investments they will sell investments that are in profit (to cover the losses). Investment professionals do the opposite, they tend to ditch loss making investments (unless there are sound reasons for recovery) and hold onto profitable investments  – the maxim of “running winners”.

B&H – Buy and Hold Investors

These investors tend to be elderly and appreciate that the markets has its ups and downs but prefer to hang onto their portfolio of blue chips regardless of financial events. They are fond of receiving dividends but often don’t like change, this reluctance about change often prevents them taking investment action – this is often referred to as Investment Paralysis.

Reactive investors

They will re-act to market events and  take action quickly by selling their investment funds as they believe by doing so they will either avoid further loss or fail to make a profit (often forgetting that typically equity movements up or down tend to make a two third reversal of a capital variance within a reasonably short period of time).

Pro-active Investors

They will be more interested in dealing strategically with an unexpected dip in an investment fund, they may consider a range of strategies, including :-

WAITING

They will allow the market movement time to reverse and then may decide  sell thereby minimizing their loss.

AVERAGING

When investments go down, it is sometimes useful to consider buying additional units at the new lower price, this will reduce the average price of all units bought. The theory being that when the investment is back in profit – the overall gain will be higher. However this is not adviseable when market is in freefall!

RISK REVERSAL

Investment Trusts are very useful investment tools, they often trade at discounts to net asset value. There may be a reason for a large discount but the discounts can be anomalous .  A good example of this is the private equity sector, several years ago values in private equity plummeted as they were affected by the debt crisis and the drop in financial markets (they often hold unquoted companies and need substantial bank finance to fund deals and also to develop companies). For that reason the market has viewed the private equity sector negatively. However research of the investment trusts that make up this sector could reveal hidden stores of value that will prove to be of immense benefit to discerning investors.

You see unlike unit trusts which are prohibited by their trust deeds from holding any more than 5% in any one company, investment trusts can hold any proportion of a single company they wish, in the private equity sector they often buy whole companies that are in distress at knock down prices. Change the management, pay off debt and invest for growth. The impact is often transformational and they often sell off the company years later at a massive profit.

In the meantime, however, the investments are often in the books at “book cost”.

So not only are you buying at a discount but the real discount to true (non stated) value may be a lot higher.

Another reason for a large discount could be bad performance – one such investment has had difficulty with a major investment in recent years and although the difficulties are now over, it’s rating and discount has been affected – however it’s problems are over – so what an opportunity to invest at a knock down price and get a nice yield.

So how can you use the discounts on investment trusts to compensate for losses on unit trusts?

Well, you could simply invest in selected investment trusts.

Or you could survey your investment portfolio you may hold some unit trusts that have fared badly and are showing a loss – we refer to this concept as risk reversal.

Example

You bought a resource unit trust for £10,000 but it is currently showing a loss of 35% so is now only worth £6500. You could of course wait for that investment to recover OR you could sell it and re-invest the £6500 into a 35% discounted investment trust.

You have therefore swopped your unit trust worth £6500 into an investment trust whose present price values the investment trust at £6500 but whose assets are worth £10,000.

As stated earlier if your investment trust has cautiously valued its internal investment holdings then you may actually have investments whose true market value exceed the £10,000.

You have effectively swopped your loss for a discount, so you are effectively gambling that the performance of the investment trust will exceed the performance of the loss making unit trust and that the investment trust discount will narrow. Quite clearly if you choose this type of strategy it is essential you take advice from an investment trust specialist.

About Ray L Best

Ray Best has had over 30 years experience of advising on complex financial matters. A published author of a number of books including “Partnership and Shareholder Protection”, Inheritance Tax Simplified”. We provide an initial meeting at no cost and only engage with clients when we can add significant value.

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