Investment trusts are sometimes put forward as a superior investment structure since they can provide stronger performance over open-ended funds. I am far from sure this is always the case.
It is scarcely a profound notion that fund returns are determined by the choice of investment strategy rather than the fund structure, although you often wonder after reading some commentary about funds. To put this in simpler terms, the fund structure is nothing more than a bucket or container designed to safeguard the rights and interests of the investor. It makes very little difference to the returns if an investment strategy is applied in an Oeic, Sicav, ETF or investment trust structure. The pricing of investment trusts can cause complications. While it is possible to access assets at a discount to NAV do not forget that if one investor is buying on a discount, another is forced to sell at a discount.
Gearing is sometimes put forward as an advantage for investment trusts as this will enhance returns if equity markets outperform the borrowing costs. However, every private client I have ever dealt with has had their affairs structured in a manner to reduce equity risks. Invariably this is done through taking long positions in cash and bonds, but geared trusts must be structurally short either cash or bonds.
Geared investment trusts push clients’ asset allocation askew and using geared investment trusts makes little sense in clients’ balanced portfolios.
“Costs are one factor that may impact the returns depending on the fund structure”
Costs are one factor that may impact the returns depending on the fund structure. Investment trusts used to have a cost advantage over open-ended funds, but since RDR the playing field has more than levelled. Looking at the All Companies sector both of the IA (using clean share classes on the Zurich platform) and AIC, there is now a slight cost advantage for open-ended funds over closed-ended funds: 0.89 per cent versus 1.01 per cent. Evidently, investment trusts are no longer universally cheaper, although there are some long-established trusts that have charges well below the average.
One example would be the Temple Bar Investment Trust. The total charges of the trust are 0.48 per cent. The open-ended Investec UK Special Situations fund is run by the same manager following a very similar investment strategy with charges of 0.85 per cent. However, the Investec UK Special Situations fund is a single-priced Oeic that can be bought and sold at NAV. In contrast the bid/offer spread on Temple Bar is 0.66 per cent, stamp duty is levied at 0.5 per cent on purchases and stockbroker commission will also be payable. Therefore, it would take a holding period of at least three years before Temple Bar becomes the cheaper option.
The chart below demonstrates the overall investor experience has been little different, whether investing in the open-ended fund, the trust NAV without gearing or the total ret-urn from holding the trust itself.
Investment trusts have an edge in their ability to hold pot-entially illiquid instruments. Illiquid assets can be a source of excess returns and this illiquidity premium can be seen as a form of compensation for denying investors access to their capital.
Since shares in trusts can be bought and sold, trusts investing in illiquid assets can provide a route to exploit this illiquidity premium yet investors can exit the investment at any time, albeit not always at NAV. We like this aspect of trusts but the approach is not without issues:
- Discounts can become very wide in trusts following these types of strategies.
- By their nature illiquid assets are difficult to value accurately and discounts can persist for extended periods.
- The illiquid nature of underlying assets can make it difficult to orchestrate a share buyback scheme to manage the discount.
We believe the advantages offered by investment trusts are either overstated or illusory. However, trusts can offer distinct benefits to more sophisticated investors seeking specialist opportunities.
Jason Broomer is head of investment at Square Mile