How size can affect returns

For many investors an investment trust with a market capitalisation under £100m constitutes small. And trusts of this size can have less desirable attributes including a higher ongoing charge because the fixed costs are spread over fewer shareholders. Larger trusts often have ongoing charges below 1 per cent, whereas smaller ones can have an ongoing charge of 2 per cent or more.

For example, JPMorgan Brazil Investment Trust (JPB) has a market cap of £23.7m and ongoing charge of 1.99 per cent, and Geiger Counter (GCL) has a market cap of £17.5m and ongoing charge of 3.34 per cent. Contrast this with Scottish Mortgage Investment Trust (SMT) with a market capitalisation of £6.68bn and ongoing charge of 0.44 per cent, and City of London Investment Trust (CTY) with a market capitalisation of £1.52bn and ongoing charge of 0.42 per cent.

Higher fees can take a sizeable chunk out of your annual returns, so over long-term periods – the timescale over which you should hold risk assets – they eat away a considerable amount of your returns.

Another problem is liquidity – how easily you can buy and sell a trust's shares. If a trust has a smaller market capitalisation and fewer shares it may be harder to get hold of them or find buyers to sell them to. But for private investors this is less of a problem as presumably you are only looking to buy shares worth a few thousand pounds, rather than a larger holding like an institutional investor.

But there may also not be as much daily dealing in a small trust. And there might be a wide bid-offer spread – the difference between the price at which you can buy and sell an investment. Smaller and less traded funds typically have a wider bid-offer spread, although if a smaller trust is traded frequently this should not be so bad.

It is never good to incur high trading costs but this is less of an issue if you hold the trust for a long time after making a one-off investment. Hopefully, strong growth in the share price will compensate you for paying a less favourable price, although dividends are less likely with a smaller fund that has a growth focus.

"A trust being small is not such an issue if you are a long-term holder, and can time when you buy and sell your shares so you get on the right side of the trade," says James Carthew, head of research at QuotedData. "But that is something you can't guarantee."

A small market capitalisation can also be a warning sign that not all is well. For example, some trusts are small because they are winding up, or their assets and share price have not increased. So if a trust is small it is very important to do your research on it, and look at things such as its performance and history.

Boards of smaller trusts may be less likely to buy back shares to control a discount to net asset value (NAV), which is not unusual with smaller vehicles. This is because it may be harder to obtain the shares if they are not traded much, and the board might be concerned that if it buys in shares the trust will become even smaller exacerbating the problems. So you could be stuck in a trust with a stubbornly wide discount.

And smaller trusts often invest in esoteric and less liquid assets that are higher risk. So really think about whether you need or want one of these in your portfolio: would adding it mean you are taking on an unsuitable level of risk for your profile? 

But don't dismiss an investment trust just because it's small.

"Consider whether a trust is small for a reason," says says Nick Greenwood, manager of fund of investment trusts Miton Global Opportunities (MIGO). "Size doesn't deter me from buying – if it's small because the performance is poor, it's the poor performance that puts me off."

Smaller funds can be more flexible and move their allocations around more because they can get in and out of investments more quickly and easily, as they are trading smaller amounts.

A smaller fund is better for investing in certain types of assets, for example, micro-cap shares. This is because the fund needs to take a meaningful position relative to its size, but generally doesn't want to own too much of one company.

Some trusts are small because the area they invest in is out of favour with investors. But should that change they could grow. "Areas go massively in and out of fashion," says Mr Carthew. "For example, JPMorgan Brazil Investment Trust launched when the Brics (Brazil, Russia, India and China) were fashionable." 

So there is a need to be selective. "If a fund invests in large liquid securities there is no advantage in it being small," says Mr Hollands. "But there is no hard and fast rule – take each one on a case-by-case basis."

Is the smaller trust, maybe with maybe higher charges and less liquidity, giving you something you can't get elsewhere? If it is doing what a larger fund could do more cheaply there is no point investing in it.

"You want it to be different and offer high growth potential," says David Liddell, chief executive of online investment service IpsoFacto Investor. "For example, Henderson Opportunities Trust (HOT) is small but you are getting a different mix of investments than with a mainstream UK equities fund."

This trust has a market capitalisation of £88m and its investments include Alternative Investment Market (Aim) and unlisted companies. It has also made good returns over the long term and has a relatively reasonable ongoing charge of 0.94 per cent. However, this could rise if the trust performs well enough to trigger its performance fee. 

Mr Carthew says if you invest in a smaller trust with higher charges make sure the returns are compensating you well for this. "You can't have a steady eddy trust with a low return that has high charges," he says.

And Mr Liddell adds that smaller trusts that invest in more unusual assets should only be held as part of a well diversified portfolio.

If a small trust is successful it may become a big trust so consider how scaleable its strategy is: if it is much larger will it be able to continue to invest in the same sort of securities using the same sort of strategy?

But you also wouldn't want to be in a trust that doesn't grow – size does matter.