Safety of a closed-ended structure

Investment trusts outperform in the long term but changes to regulations and concerns about liquidity stress the need to understand which groups offer the best chances of performance.

The question and answer session at the end of the regular Association of Investment Companies private investor roadshows sparks the most interesting discussions.

There is a degree of comparison with open-ended investment companies with the general contention that, over the long term at least, investment trusts tend to outperform. The arguments centre on lower management fees and the benefits of gearing in a rising market, although the closed-ended structure does hold advantages in difficult trading conditions. While comparing similar funds in both camps might prove revealing, it is likely to be more useful to see which trusts had been the best in which to invest over various periods.

The reality is that a true comparison between these two collective vehicles would be misleading. The share price of an investment trust can fluctuate out of line with the performance of the underlying assets, which can prove both an advantage and a disadvantage.

”Some investment areas are particularly well suited to investment trusts”

And for some trusts there can be liquidity concerns. But there is little doubt that a closed-ended vehicle suits some asset classes much better.

This is made clear in some of the trusts that are among the best performers. Variously topping the tables are trusts specialising in property, hedge funds, natural resources and Russia – hardly the most liquid of markets in which to invest. Indeed, emerging markets, commodities and natural resources and hedge funds all make several appearances in the leaders’ lists. It is clear that some investment areas are particularly well suited to investment trusts.

JP Morgan Russian Securities, the leader over 10 years having multiplied the value of an investment back at the start of the new millennium more than 11-fold, features in the top 20 trusts over one year as well, but not over three and five. First State’s Scottish Oriental Smaller Companies must take the prize as the most consistent performer, staying in the top five for all of the four periods reviewed. But Aberdeen Asian Smaller Companies runs it a close second, only dropping out of the top five once, over five years, when it ranked sixth. (article continues below)

Asia and Latin America both feature strongly. Of course, the number of trusts targeting East Asian markets far outnumbers those investing in South and Central America. However, it is notable that there are no fewer than 31 instances of a trust investing in this region featuring in the top 20 over one, three, five and 10 years. The peak representation is over five years, when more than half the trusts in the top 20 were Asia Pacific in some form or another.

South and Central America, in contrast, features just twice – both being the BlackRock Latin America trust which, as well as coming second over five years, makes the top 10 – just – over 10. Hedge funds, another sector where the range of trusts remains limited, has its moment of glory in just one time-frame – three years. No fewer than six trusts feature, one less than the South East Asia representation, with BlueCrest and Brevan Howard, asset managers, sharing the honours.

While emerging markets in general and East Asia in particular have delivered the most consistent strong performance during the past decade, it is worth making the point that many sectors feature in one form or another. Global Growth, Private Equity, UK Smaller Companies – all provide contenders in the charts. And just as the choice of trusts that have done well is wide, so are the management groups that deliver the results.

Aberdeen Asset Management does stand out, though, if you look at the top 20 performers. With three funds featuring in the 10-year tables, four over one year, five for the five-year tables and seven in the three-year charts, they have more representation among the leaders than any other manager. While most are Asia Pacific or single country funds in that region – a tribute to Hugh Young, who is based in Singapore and heads their investment operations – Murray International, a large Global Growth and Income trust managed by Bruce Stout, also features.

It is hard to draw specific conclusions on which trusts to recommend or, indeed, as to whether the close-ended route is to be preferred to open-ended vehicles. What is clear is that where an asset class is hard to access or difficult to manage in a liquid form, then investment trusts should provide a better solution. Instances of a sector becoming fashionable briefly, as with hedge funds, for example, hardly provide a sound case for including them in a diversified portfolio.

But changes to the regulatory landscape could alter the perception of investment trusts as a route to market. While there are more factors to take into account, such as the borrowing powers of a trust, they seem likely to feature more strongly in a world where commission has been relegated to the sidelines. Understanding how they operate and which groups and trusts offer the best chance of consistent performance may become a higher priority.