We recently summarised some Collins Stewart research that compared 22 investment trusts to open-ended funds run by the same fund managers, and with similar investment goals and strategy. It found that more than three quarters of the investment trusts outperformed the open-ended equivalent. This week, we take a more detailed look at the investment trust/unit trust comparison.
Alan Brierly, who conducted the Collins Stewart research, cited lower management fees, the positive impact of gearing and share buybacks as contributory factors to these excess returns. You can also often buy investment trusts at discounts to net asset value (NAV) which represents a significant price differential between comparable investments.
There's no arguing with lower fees and discounts to NAV. But gearing is more complex. The downside is that while gearing can boost returns in rising markets, it also compounds losses in falling markets. This feature, if used by an investment trust, undoubtedly makes its shares more volatile and risky.
"Providing that returns on equity exceed the cost of borrowing over the life of the investment, then returns will be enhanced by gearing," says Mr Brierly. "While acknowledging that losses can be compounded in falling markets, favouring unit trusts because they will fall less is not the most convincing of arguments."
Not all black and white
However, Mick Gilligan, head of research at brokers Killik & Co, says before you move from an open-ended fund into an investment trust with debt, you should consider how bullish you are on the sector in which its invests. He also cites three other big considerations:
■ Dealing costs: although switching to an investment trust with lower management fees could be profitable if you intend to hold it for a long time, buying it will result in dealing charges. And watch out for wide bid/offer spreads - the difference between the buying and selling price.
■ Performance fees: these are far more common among investment trusts than open-ended funds. Watch out especially for investment trusts which have not been performing well - and are not currently charging performance fees - because when performance turns, the fee will kick in, resulting in higher costs.
■ Moving discounts: there's no point buying an investment trust's shares because of a discount to NAV, only to then see it widen further. But if a discount looks like it is going to tighten soon, then it is a good time to get in, especially if you intend to hold the investment trust over the long-term. "If a board has started buying back shares in a meaningful way then this should be an indication that the discount has reached its floor," says Mr Gilligan. He adds that if you are going to switch out of an open-ended fund, there should be a discount of at least 10 per cent, unless it is an investment trust that usually trades at a premium or tight discount, when a discount of less than 10 per cent could still be a good opportunity.
There may also be times when the reverse course of action - switching from investment trusts to open-ended funds - is the more appropriate course of action. See .
Investment trusts which beat their open-ended equivalents
| Investment trust* | TER (%) | Discount to NAV (%) | Outperformance (%)* (1) | Open-end equivalent fund | TER (%) |
|---|---|---|---|---|---|
| Aberdeen Asian Smaller Cos | 1.57 | -4.66 | 0.7 | Aberdeen Global Asian Smaller Cos | 2.04% |
| Aberdeen New Dawn | 1.21 | -7.83 | 1.8 | Aberdeen Asia Pacific | 1.84% |
| Baring Emerging Europe | 1.23 | -10.18 | 1.6 | Baring Eastern European | 2% |
| BlackRock World Mining | 1.47 | -14.43 | 2.7 | BGF World Mining | 2.07** |
| Edinburgh Dragon | 1.29 | -8.19 | 2 | Aberdeen Asia Pacific | 1.84% |
| Fidelity European Values | 0.94 | -16.18 | 1.8 | Fidleity European Fund | 1.68% |
| Fidelity Special Values | 1.24 | -9.6 | 1.3 | Fidelity Special Situations | 1.69% |
| Henderson Far East Income | 1.26 | 2.82 | 3.7 | Henderson Asian Dividend Income | 1.56% |
| Henderson TR Pacific | 0.92 | -10.5 | 1.4 | Henderson Asia Pacific Capital Growth | 1.77% |
| JPMorgan European Smaller Cos | 1.21** | 18.27** | 5.6 | JPMorgan Europe Smaller Cos Fund | 1.68** |
| JPMorgan Emerging Markets | 1.21 | -7.84 | 1.2 | JPMorgan Emerging Markets Fund | 1.67** |
| Jupiter European Opportunities | 1.17 | -6.67 | 1.6 | Jupiter European Fund | 1.79** |
| Lowland | 0.73 | -6.57 | 1.7 | Henderson UK Equity Income | 1.75% |
| Polar Capital Technology | 1.19 | -0.94 | 0.1 | Polar Capital Technology Fund | 2.76** |
| Ruffer Investment Company | 1.22 | 6.44 | 2.7 | CF Ruffer Total Return | 1.54% |
| Temple Bar | 0.57 | -0.7 | 0.7 | Investec UK Special Situations | 1.61% |
| Templeton Emerging Markets | 1.28 | -6.28 | 7 | Templeton Emerging Markets Fund | 2.5** |
Source: Investors Chronicle, *Collins Stewart, **Morningstar.
Data as at 25 March 2011. NAVs are total return annualised, TERs for unit trusts are supplied by the fund provider unless indicated otherwise.
Look at the whole universe
Switching to the investment trust 'mirror' of an open-ended fund could be a good strategy if you want exposure to a particular fund manager, but to access them at lower costs. But in each case suggested below, the investment trust is not necessarily the best in its sector, but rather a more cost-efficient and ultimately better performing option than its open-ended peer.
Aberdeen Asia Pacific Fund to Aberdeen New Dawn/Edinburgh Dragon
Aberdeen has one of the most experienced Asian equity teams, led by Hugh Young. Most investors have flocked to open-ended funds such as Aberdeen Asia Pacific, with a relatively high 1.75 per cent annual management charge (AMC). But you can buy into the same expertise via Aberdeen New Dawn and Edinburgh Dragon, two of the best performing Asian investment trusts, which have AMCs of 1 per cent . You can buy Aberdeen New Dawn at a discount to NAV of nearly 8 per cent and Edinburgh Dragon at a discount of around 8.2 per cent.
Over five years, Edinburgh Dragon investment trust has outperformed Aberdeen Asia Pacific by 2 per cent, in terms of annualised NAV total return, while Aberdeen New Dawn investment trust has outperformed it by 1.8 per cent over 10 years.
To see our profile on Edinburgh Dragon, click here.
Fidelity Special Situations to Fidelity Special Values
You may well hold the Fidelity Special Situations fund, run by star fund manager Anthony Bolton until his retirement in 2008 and now by up and coming manager Sanjeev Shah. But did you know there is an almost identical investment trust, Fidelity Special Values? This has also been run by Mr Shah since 2008, and the Collins Stewart research finds that the investment trust outperformed Fidelity Special Situations by 1.3 per cent over 10 years, in terms of annualised NAV total returns.
You can buy the investment trust at a discount of around 9.6 per cent which Mr Brierley says is "excellent value." Perhaps of even greater importance is the investment trust's 1 per cent annual management charge (AMC), 0.5 per cent cheaper than Fidelity Special Situations which has a 1.5 per cent AMC.
"We would also note that the dividend yield of the investment trust is relatively attractive, 1.83 per cent versus zero for the open-ended fund," concludes Mr Brierley. "A switch out of the unit trust and into the investment company is compelling."
Schroder UK Alpha Plus to Schroder UK Growth
Schroder UK Growth investment trust has been managed in line with the Schroder UK Alpha Plus unit trust since 2006, and both are run by Richard Buxton (see our ). The investment trust has underperformed the open-ended fund over ten years by 3.2 per cent, but its performance looks like it is turning and it has a much cheaper AMC of 0.4 per cent.
"The investment trust has had a chequered past but after a near-capitulation phase during 2008, the performance has since improved materially," says Mr Brierley. "The NAV total return of UK Growth is some 7.5 per cent ahead of UK Alpha Plus since the beginning of 2009."
The investment trust has a higher yield, 2.08 per cent in contrast to 0.5 per cent for the open-ended fund. The trust is trading at a discount to NAV of 4.1 per cent, so now might be a good time to buy, because if its performance improves, the discount is likely to tighten.
However, Schroder UK Growth investment trust levies a performance fee of 10 per cent of any out performance of the FTSE All Share, albeit with a 0.23 per cent cap, so if the better performance continues the fees will rise.
Jupiter European Fund to Jupiter European Opportunities
Jupiter European Opportunities investment trust is the top performing Europe investment trust while Jupiter European, a unit trust, is among the top few Europe funds. Both are run by Alex Darwall, and if you want Europe exposure in your portfolio these are both great options. But there is a crucial difference – the open-ended fund has an AMC of 1.5 per cent in contrast to the investment trust which has an AMC of 0.75 per cent.
This has helped the investment trust outperform its open-ended peer over one and five years, which adds up to a NAV annualised total return out performance of 1.6 per cent over five years. This could build up to a significant difference if held over many years. You can also buy the investment trust on a discount of around 6.67 per cent.
However, the investment trust charges a performance fee of 15 per cent of the out performance of the FTSE World Europe ex UK index. Nevertheless, Mr Brierley says: "It is difficult to argue why investors should not switch out of the open-ended Jupiter European Fund. We would note that the manager, Alex Darwall is one of the largest shareholders in the investment trust, with a shareholding currently valued at £11m - if it's good enough for the manager…"
