Investment trusts show their class

Kepler has run its slide rule over the performance of pairs of funds that invest in continental European companies. It focused on seven sets of “siblings” – open-ended funds and investment trusts managed by the same investment management company over the period considered, run according to the same investment objectives, and listed in equivalent AIC and Investment Association sectors.

The results are pretty conclusive. Over five years to 22 May, six of the seven investment trusts outperformed their open-ended fund equivalents. That’s the case whether you measure returns by share price performance or on the basis of net asset value. In other words, even when you take into account the fact that shares in investment trusts often trade at a discount to the value of their underlying assets, open-ended funds have still lagged.

Kepler also points out that four of the seven investment trusts considered produced returns that exceeded the returns generated by their benchmark indices. That is, an active investment strategy paid off for investors. Only two of the open-ended funds managed to do this.

In some cases, the gap between seemingly very similar investment trusts and open-ended funds is remarkably wide. Fidelity European Trust, for example, beat its open-ended counterpart, Fidelity European, by 12.3 percentage points in terms of net asset value performance. On share price returns, it was 24.8 percentage points ahead over the five-year period.

What explains such outperformance? Kepler thinks gearing is a large part of the explanation. Investment trusts can take on borrowing, which increases returns when the portfolio value is rising, but this is not an option for open-ended funds. It also points to the potential for investment trust discounts to narrow, which gives share price performance an additional boost; this effect explains Fidelity European Trust’s share price strength, for example.

Another factor highlighted by Kepler is the investment trust structure itself. Managers are working with fixed pools of assets rather than having to worry about inflows and outflows of investors’ money, as in an open-ended fund. “This means they can stay more fully invested over time and don’t have to sell stocks to maintain certain allocations during periods of negative flows,” Kepler points out.

There are no guarantees. Some of the advantages of investment trusts – including gearing and the discount effect – can also become disadvantages, particularly during periods of market setbacks or declining investor sentiment. And managers of these sibling funds do sometimes take a slightly different strategic view about how to manage each of them, which can lead to variations in performance (for better or worse for one or the other).

Still, Kepler’s analysis is another reminder of the potential of investment trusts to outperform, particularly in rising markets. That’s food for thought for investors in Europe, where there is currently a great deal of positivity about the equity market outlook.

The research is also worth considering by advisers who think of investment trusts as primarily vehicles for holding illiquid assets. It’s true that the structure of an investment trust is helpful in this regard, providing an accessible route in and out of illiquid areas such as private equity, real estate and infrastructure too. But that’s not to say investment trusts don’t have advantages in more conventional asset classes as well.