Investors have a good selection of specialist sectors to choose from, and the range is growing – from more established specialist sectors such as commodity and natural resources funds and financials, to newcomers investing in such diverse areas such as forestry, infrastructure, securitised debt and litigation.

‘Recently, all IT launches and most fund raising has been specialist in nature,’ says James Budden, marketing director at Witan Investment Trust, ‘The closed-ended structure lends itself to investing in illiquid assets and it offers both the manager and the investor time to realise value in those assets and ride ups and downs. Open-ended funds face the threat of having to unwind positions unprofitably when they need
to redeem units.’

A narrower focus
The predicament for investors is, while diversification is generally recommended within a portfolio, how should investors approach some of these new areas of investment, which promise so much? The key principles are to invest for the long term, know what you are investing in and appreciate how the structure of investment trusts particularly suits specialist sectors. But, as with any investment decision, the first step is to weigh up how much risk you are prepared to take.

‘Specialism is interesting but should not be the be-all and end-all of any investment portfolio,’ says John Moore, divisional director of the IT management service, Brewin Dolphin. ‘There is nothing wrong with a whole host of more traditional investment products as well. If you tend to go off in one area or another you tend to get a more extreme performance and you may think that is a good thing but sometimes it isn’t.’

An enthusiast of specialist trusts, Moore says he still always tries to maintain a balance of equities, bonds, property, and other investments so not to be wholly exposed to one particular trend. Investing for the long term should iron out a lot of risk concerns and also counter another concern about ITs, that of illiquidity.

Daniel Lockyer, fund manager at Midas Capital says that, because of their closed-end structure, ITs are the right vehicle for specialist areas. ‘You have the closed-ended protection as a manager, so you are not having to deal with inflows and outflows, which would affect your portfolio.’

He adds, ‘A classic example would be private equity, where you are taking a very long-term view so you don’t want inflows because that would dilute the investment and you don’t want outflows because you would have to sell before they are due to ripen.’

The escape clauseInvestors are not entirely locked in of course. As Lockyer points out, being closed-ended and listed on the stock market there will be a certain level of liquidity with investment trusts. ‘If you are a smaller investor, with, say, £10,000 or even £100,000, it should be easy to get rid of that amount or buy into that over the course of a day or two or even in one deal.’

But you do need to consider what you are investing in and why. ‘One of the good things about investment is that, if you understand what you have got you will understand what will make it go up and what will make it go down,’ says Moore, drawing attention to Warren Buffett’s maxim that you should only invest in things you understand.

‘But if you don’t understand it, or if you don’t know if the manager is performing well, or if he has just been lucky, or is taking too much risk, or is not performing well and that is justified or not, that is when you are likely to make an irrational decision. So that
is a huge risk.’

Private investors also have to understand it may not be easy to get all the information you want or need on some of these specialist vehicles. As Paul Craig, fund manager at New Star Asset Management, says, ‘There are probably some things you need to be more aware of with specialist mandates rather than funds just investing in listed equities. You have to be aware that there is much less transparency with a specialist fund than there is with a general vanilla fund.  For private investors, it may be difficult to get the necessary information to gauge how much leverage there is within trusts or what the net asset value (NAV) actually means.’

Research is the key
The trick is to really do your research and take a long-term view, because investments into these areas generally require strategies with a longer-term investment horizon. Craig points out, ‘Their assets tend to be more illiquid and the price is likely to be driven more by news flow and sentiment. If news is positive, then sentiment improves and discounts will narrow and vice versa. You need to do more homework before investing and invest for the long term.’

Within the specialist sectors, utilities is one area John Moore favours. He argues that ‘Utilities are a reasonably straightforward business to understand. They tend to serve a certain amount of customers a certain product and those customers 99.9 times out of a 100 have to pay their bill, otherwise they will be cut off. As an absolutely essential service there is quite a regulated, and therefore dependable, income stream. So, as
a result of that, there are quite dependable returns.’

He says that a lot of people underestimate the degree of change going on in the utility market, particularly in electricity. ‘In the UK and Europe, we have seen quite a lot of consolidation. The industry needs to build super-companies to build infrastructure that can cope with the change from fossil fuels to nuclear or wind power or hydropower. That is going to cost £20 or £30 billion and if you are a £10 billion utility company you simply couldn’t afford that. So that has been driving consolidation in Europe.’

He highlights the US where the market is very fragmented, with state owned utility companies and opportunities therein. Or Japan where utility companies offer yields of three to five per cent, which is substantially higher than the bond yield.

Moore says, ‘The average investor simply can’t access that type of thing but if you look for a specialist manager then you can. For example, you have the Ecofin Water & Power Opportunities trust, which is investing internationally.’

More exotic locations
Another area where caution should be taken is securitised debt, which can be complicated. Moore explains that ‘Securitised debt is issued by special-purpose vehicles which may have three or four types of debt which are secured on assets. There are various complications within that and, in certain circumstances, the investment merits change and the risk profile changes.’

He points out that ‘One of the popular securitisations is based on mortgages. People thought they were exposed to mortgages only but they were actually exposed to a structure which was three or four layers deep, as part of the vehicles might have borrowings themselves managed by someone perhaps taking risk investors were unaware of. So may think you own something you think is safe but all of a sudden you get wiped out. If that can happen to big investment banks populated with probably the greatest talent there is, it is probably not an area where the average investor should tread.’

Tim Cockerill, head of research, Rowan & Co likes the concept of forestry as an investment, through things such as Cambium Global Timberland and Phaunos Timber. He argues that forestry is certainly worth looking, for diversification and long-term returns.‘Forests are being depleted at an alarming rate and clearly that can’t
go on for a number of reasons. The demand for wood itself is growing, so the importance of well-managed forestry is going to increase. At the moment, the correlation of the asset class with, say, shares, is very low which is good, but there is a danger that as it becomes more accessible to ordinary investors it would become more correlated. However, I think that is a long way off.’

Schroder has caused some excitement launching an agricultural land trust, which Cockerill says he is sure will fit in the specialist sector category. ‘At one level that sort of specialist trust looks quite good. They are buying agricultural land on a global basis, and that makes sense because of the growing population and demand for food, driving land values. But there are a lot of issues that you may say are environmental. It may be there is a piece of land, which needs irrigation, it’s next to a river but there may be political consequences of drawing off lots of water for irrigation to the people down stream.’

Cockerill asserts that ‘For me quite often with these specialist vehicles, you start to enter territory where you have to think about things which aren’t necessarily obvious at the outset. It is not like buying a straightforward equity fund where it is about management, business model, etc. But there are some interesting opportunities and that agricultural land is one of them.’

Proceed with caution
Within the infrastructure sector you have the likes of 3i Infrastructure, Babcock & Brown Public Partnerships and HSBC Infrastructure Co. Tim Cockerill says that ‘If you look at 3i or HSBC, for example, you are effectively buying a property fund with a very secure tenant and income stream and they are quite suitable for cautious investors who want income. Performance has been a bit lumpy, so I think there is a case for arguing about the time of purchase, but as a concept they are quite interesting.’

However, the problem with new trends is that it can be too easy to venture in just because a fund is offering something different. For example, Cockerill cites Juridica Investments, which specialises in litigation. ‘As a general rule, when you are looking at specialist areas like litigation, investors have to be very careful, because you are looking at an asset which has not necessarily got any tangible value as such.’

He adds, ‘If it is an area about which you know very little how do you actually assess the risk and reward profile of an investment like that?’

And Witan’s James Budden warns that ‘Managers tend to bring to market things they can sell - i.e. what is popular at the time. These funds tend to be higher risk as they are investing specifically in one area and so do not offer risk mitigation through diversity.’

By their nature, such trusts and sectors will provide investors with something less correlated to equity markets. But with the prospects of higher returns come a greater number of pitfalls. Investors have to be aware of these and select specialist funds carefully within the context of a balanced overall portfolio.