The case for Oeics versus trusts

After waves of articles pointing to the merits of investment trusts, one IFA questions the idea that they are both cheaper and better performers than their Oeic equivalents

Craig Davidson 160 byline

Over the last year or so the use of investment trusts by IFAs has been coming under the spotlight in the run up to the RDR deadline. While there have been many articles extolling the virtues of investment trusts, and indeed criticising IFAs for not using them more, few have focused on the merits of Oeics. There seem to be few myths about cost and performance and comparisons tend to be a case of “apples and pears”. The fact is Oeics are often the preferable option and here I try to set out their use.

Starting with cost, let us look at the total expense ratio. Just like Oeics, investment trusts have a wide range of TERs. For example, in the UK large cap blend category there is the Temple Bar trust with a TER of 0.44 per cent, but there is also the Invesco Perpetual UK Equity Trust running at 1.1 per cent. But crucially, when this is compared with the typical Oeic at 1.6 per cent, we are not comparing like with like. The Oeic TER includes the IFA’s ongoing trial of 0.5 per cent.

In addition, no mention is made of the initial cost of buying the fund. Ignoring the IFA’s fee, buying an Oeic now, through a platform, usually carries no front end fee or bid/offer spread. Buying into an investment trust is buying shares, and there will often be a bid/offer spread and/or dealing fees.

Cost influences performance, and much is made of a supposedly superior track record with investment trusts. But how do we compare the performance of investment trusts and Oeics when not all sector classifications match? There are only 24 Morningstar sectors that are reflected in both fund types.

Furthermore, we need to take into account the number of funds in each sector. According to Morningstar, there are 696 investment trusts and over 28,000 Oeics. Even if we narrow the Oeic range down to only retail funds with minimum initial investments of less than £5,000, there are still 4,423 funds. That means we have an extreme overweighting towards Oeics.

For example, the Asia Pacific ex Japan sector has seven investment trusts and 78 Oeics, global large cap growth has three trusts and 48 Oeics and UK large cap blend has 20 trusts and 265 Oeics. If we simply took the average across the sector, the Oeic performance would always be weighted by the larger number of funds. So how do we avoid that?

FS 2611 Trends

Focusing on each sector, I have taken the top five investment trusts and Oeics to produce a sample of 10 funds per sector. I have then taken the top five performers over five years. Column two of the chart shows how many of those top five are investment trusts versus Oeics and it is interesting to note how many sectors have Oeics as the majority in that top five.

The next step was to compare the combined performance of those top five IT against the top five Oeics as stand-alone portfolios, again over five years. Column three indicates which portfolios would have provided the greatest return. Interestingly, out of 23 sectors Oeics provided the better return in 12 – an even match.

Moving back to the TER comparison, column four shows the average TERs for those top five funds and simply compares them. The ones in bold indicate the cheaper average TER after adding back in the IFA’s 0.5 per cent. I have not taken into account any platform fee. That is an important side issue – If investment trusts improve their distribution by becoming available on platforms, they will have the extra fee to contend with.

So there you have it. This may not be the most scientific research available, but it is logical and certainly questions the myth that investment trusts are somehow a more worthy choice above Oeics.

But what of the other issues when making this comparison? The two main points are gearing and the liquidity issue. Starting with gearing, that works both ways. If the trust goes wrong, and has a high level of gearing, that could spell disaster for the investor, and it is not just a theoretical risk. One only has to look at the performance charts on some investment trusts to see the sort of price drop investors can be faced with. That is another level of risk which most middle-of-the-road investors do not need to take when there is an equally good Oeic on offer.

Finally there is the liquidity issue. By nature, with a closed-ended fund the fund manager can restrict redemptions and that may be a preferable position with some asset classes, such as direct property funds. However, for others, like UK equities, this simply adds another element of risk to the investor. One thinks of the large market value adjustment on With Profits funds – they may work for the remaining unitholders, but for most clients they represent an unfair restriction on withdrawing their own money.

In summary, the most important observation with this research is the fact that there is no trend. Sometimes Oeics come out on top, sometimes its investment trusts. In other words it is not the vehicle that is determining performance, it is the manager. There are clearly higher risks associated with investment trusts, and certainly for this IFA, based in the West Country with a largely conservative client base, I do not see any extra benefit an investment trust gives to warrant that extra risk. But for those clients happy with the extra risk there are some good investment trusts which could and should be considered.


Craig Davidson is the managing director of DavidsonsIFA