Investment trusts prove their mettle
David Prosser on closed-ended funds outperforming open-ended counterparts.
Do investment trusts really outperform open-ended funds? It’s a claim often made by investment trust supporters, who point to structural advantages such as the potential to take on gearing. But long-term data isn’t always easy to come by to justify such assertions.
For that reason, research by Mick Gilligan, one of the sector’s most widely respected analysts, makes interesting reading. Gilligan isn’t one to pull his punches – he’s been a vocal critic of underperforming investment trusts, including in fashionable sectors – so it’s worth paying attention to his number crunching.
Importantly, this analysis, which is published in his new book, Investment Trusts Explained, looked at just four areas of the market, in sectors defined by the data analyst Morningstar: UK large-cap equity, UK flexible cap equity, Europe equity (excluding UK) and global large-cap blend equity.
The reason for keeping the study so limited is that Gilligan only wanted to look at areas where there were sufficient numbers of investment trusts with very long-term track records. Without such screens, there is a danger that any analysis will be skewed by the performance of a single fund.
The results will raise eyebrows. Looking at rolling ten-year periods, Gilligan found that investment trusts outperformed comparable mutual funds with remarkable consistency. In UK flexible cap equity, investment trusts outperformed over 70% of the ten-year periods considered; that rose to 90% and 91% respectively for UK large-cap equity and global large-cap blend equity.
For Europe equity (excluding UK), investment trusts outperformed over 100% of the ten-year periods in the study.
Longer-term comparisons are even more conclusive. For three of the four sectors that Gilligan looked at, investment trusts outperformed over every single 25-year period considered. And in the remaining sector, UK flexible cap equity, investment trusts outperformed over 82% of the 25-year periods.
There are some caveats here. First, we know that past performance is not necessarily a guide to the future. Also, we’re looking at only four areas of the market – investment trusts and open-ended funds invest more widely. The study was also focused on net asset value performance rather than share price returns; the fact that investment trust shares sometimes trade at discounts or premiums to the value of their underlying assets will mean investors haven’t always achieved the returns quoted in the study.
For Europe equity (excluding UK), investment trusts outperformed over 100% of the ten-year periods in the study.
David Prosser
Nevertheless, the data gives investment trusts a much more comprehensive victory than might have been expected. Other research on historical performance has also found that investment trusts have tended to do better over longer-term periods – but the data has rarely been as convincing as in this case.
Still, there are rational explanations for investment trusts’ outperformance. Gearing, clearly, is part of the story – investment trusts can take on borrowing to accelerate growth, a tactic that is off limits to open-ended funds; over time, assuming markets rise, this can have a significant positive impact. The governance of investment trusts, led by boards with a responsibility to deliver shareholder value, is also important.
Low charges in the sector have played a part too, though many open-ended funds these days are also very competitively priced.
There’s a broader point here too. It has become common to highlight the usefulness of investment trusts for securing exposure to illiquid asset classes such as infrastructure, property, private equity and private credit. But while it’s true that the structure of an investment trust has additional value in these asset classes, protecting investors from being stuck with hard-to-sell assets, the implication of this argument might be that it is better to look to other types of funds when it comes to more conventional equity investment.
Based on the results of this study, however, that could be a mistake, and investors should consider investment trusts for their standard equity exposure.
Investment Trusts Explained is in bookshops now.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
