IT geek: get the best value for money with investment trusts

Investment trusts have been found, on average, to be more expensive than other types of funds available to private investors. And a number of investment trusts have performance fees, something virtually unheard of among open-ended and exchange traded funds (ETFs), with the exception of some targeted absolute return funds.

But these are average figures and you don’t buy the average investment trust because it doesn’t exist. You buy real investment trusts, and some of these have the lowest charges of all actively managed funds.

A few trusts with high fees can push up averages, and high fees and performance fees in particular are often found on trusts that invest in esoteric assets that many investors are unlikely to need exposure to. So if you do your research you should be able to find some very cost-effective and good investment trusts.

When considering the costs of a fund such as an investment trust the first thing that springs to mind is probably its ongoing charge. But the total cost of investing includes more than just this. You also have to pay a number of charges to the investment platform or broker you use to buy the fund. Different brokers and platforms have different charging structures from each other, meaning that there is great variation in the total cost of investing in a fund. So in this article I am going to focus on fund charges and expenses, as represented in the ongoing charge and performance fees, rather than the total cost.

But when doing your own research on a fund you have to factor in platform and broker fees too, so make sure you know what the total cost of investing in a fund before you commit money to it. 

Another thing I am going to ignore – and would encourage you to ignore too – are key information documents (KIDs). Since the start of 2018 investment trusts have been legally obliged to produce these documents, which purport to provide information on features such as their expected risk and return, and costs. However, the methodology for calculating the figures provided in these documents is questionable. With charges, for example, there is a lack of consistency in the way that costs are calculated by different trusts, meaning that cost figures in investment trust KIDs cannot be fairly compared with each other.

If you want to read more on why I and many industry participants don’t like KIDs see my June 2018 IT geek column.

How to start

The starting point when looking for a cheap investment trust is not ongoing charges. You first need to establish what your asset allocation is going to be. When you know this, you can then look for investments in the areas you have chosen, and compare the costs of the funds available in each area to each other.

So, for example, if you have decided that 10 per cent of your investment portfolio should be allocated to Japan, compare the costs of the various Japan funds on offer. Don’t, for example, look at the costs of Japan investment trusts, see there is a UK trust with a lower charge and then opt for that because it is cheaper. You or your adviser have set your asset allocation because that is what is appropriate for you, so stick to it until your circumstances suggest it needs changing. You should not change your asset allocation because you’ve found a cheap fund in another area. The fund must suit your personal investment objectives – not the other way around.

Where to check charges

When you are looking for lower-cost funds to express your asset allocation, you need to establish what is cheap, and whether a fund’s ongoing charge is reasonable. To get a idea of this you should compare like with like. So when looking at an investment trust focused on the area you are looking to invest in, compare its charges to those of its Association of Investment Companies (AIC) sector peers, and open-ended funds focused on the same area.

A good place to view investment trust charges alongside each other is the AIC website. This enables you to pull up all the trusts in one sector on a single screen, with data relating to these trusts such as their ongoing charges plus any performance fees. This is particularly helpful as some other data sites do not include the performance fees which can make a trust’s charges significantly higher.

The AIC sector pages include the sector averages for these figures so you can compare a trust’s ongoing charge plus performance fee against this to see if it varies greatly from its peers. The sector pages also allow you to sort the figures from low to high or vice versa, so you can get an idea of where a trust’s ongoing charge plus performance fee ranks within its sector.

If an investment trust doesn’t have a performance fee there will be no difference between its ongoing charge, and ongoing charge plus performance fee figures. But, confusingly, if an investment trust that can levy a performance fee hasn’t done this in its last financial year, its ongoing charge, and ongoing charge plus performance fee figures will also be the same. So it may not be apparent on the AIC’s sector pages whether a trust has a performance fee, meaning you need to dig deeper to establish this.

It is really important to check if a trust has the ability to charge a performance fee because this could push up the ongoing charge in future years. If you are going to invest in a risk asset such as an investment trust you should hold it for at least five years, so establishing what could happen in the future is very important. 

Jupiter European Opportunities Trust (JEO) is a good example of how much more expensive a performance fee can make a trust. Its ongoing charge is 0.9 per cent – not unreasonable for a good active fund. But if you add on the performance fee for its last financial year you may be shocked to see that what seems like a reasonably priced investment trust actually costs a whopping 2.5 per cent.

To find out if an investment trust has a performance fee, go to its home page on the AIC website, and then click on the ‘charges and gearing’ tab. This has a description of the trust’s fee arrangements which say if it has a performance fee, even if it hasn’t been levied in the last financial year.

Other places where you can find information on whether an investment trust has a performance fee include the Hargreaves Lansdown website, which indicates this on each trust’s home page. And the trust’s annual report should have full details of its performance fee arrangements, although this information is not always set out in the first few pages, so be prepared to delve deep.

When a performance fee is acceptable

Having a performance fee is not a reason to totally rule out investing in a fund. A key point is how it is structured: what is the most that you might have to pay if it is levied – is there a cap? Is there a high-water mark, whereby the fund doesn’t just have to meet its hurdles in the current financial year to gain the fee but, for example, recoup any underperformance from the previous year? And does the fund have a low base fee, meaning that even with a performance fee added on the charges come to around the level, or not much more than those, of a fund without a performance fee?

A good example of an investment trust with a tolerable performance fee is Henderson Smaller Companies Investment Trust (HSL). In its last financial year its ongoing charge plus performance fee added up to 0.98 per cent, which is not dissimilar to what you might pay for a smaller companies fund without a performance fee. And within the AIC UK Smaller Companies sector, it is one of the lower fees: the sector average ongoing charge plus performance fee is 1.08 per cent, and out of 20 smaller companies trusts Henderson Smaller Companies is seventh cheapest.

There are a few reasons for this. Henderson Smaller Companies has a very low base fee, meaning its ongoing charge without the performance fee is only 0.41 per cent. This trust is helped in this respect because it is larger than most of its sector peers with a market capitalisation of over £600m, which means fixed costs are spread over a greater shareholder base.

The performance fee is 15 per cent of any outperformance of its benchmark – Numis Smaller Companies Index ex Investment Companies – on a total return basis. And – importantly – this investment trust is subject to a limit on the total management fees payable in any one year of 0.9 per cent of the average value of its net assets during the year, calculated monthly. So, however well Henderson Smaller Companies performs, it cannot charge fees in total of more than 0.9 per cent, the reason why its ongoing charge, which includes a few more costs such as administration charges, is only 0.98 per cent.

What’s particularly relevant is that Henderson Smaller Companies has beaten its benchmark and most of its sector peers over three and five years, so you are very well compensated for its fees.

Good low-cost investment trusts

In other sectors you can find really low-cost trusts without performance fees that have delivered excellent performance. Perhaps the most outstanding example is Scottish Mortgage Investment Trust (SMT), one of the best performers of all global investment trusts which has beaten broad global indices such as FTSE World and FTSE World ex UK over three and five years. It has longstanding managers – James Anderson who has run it for 19 years and Tom Slator who has run it for more than nine years. But it has an ongoing charge of only 0.37 per cent – one of the lowest of all active funds.

Part of the reason for its low charge is its size – the trust has a market capitalisation of around £7.17bn.

City of London Investment Trust (CTY), meanwhile, has an outstanding record of paying dividends. It has increased its dividend every year for 52 years, and paid 17.7p per share in respect of its last financial year, so has an attractive yield of about 4.5 per cent. Despite this, the trust has a very low ongoing charge of 0.41 per cent.

It also makes good total returns over the long term, beating the FTSE All-Share index. But it can lag sector peers that allocate to smaller companies enabling them to deliver stronger growth. City of London Investment Trust tends to focus on stable, dividend-paying larger companies.

It has a very longstanding manager, Job Curtis, who has run it since 1991.

Look beyond investment trusts

Getting the best value for money when investing means searching widely and, in some cases, investing in an open-ended fund with a lower charge. If you are looking for a fund in a particular area, for example Asian equities, and the most reasonably priced option that meets all your other criteria is an open-ended fund, it would not make sense to opt for an investment trust just because it’s an investment trust, as its higher charges will eat into your end return. If you find a similar investment trust and open-ended fund that have both performed well, but the open-ended fund is cheaper, it may make sense to go for that.

This situation can arise when you get a good manager who runs a number of similar funds, some of which are open-ended and some of which are closed-ended. An example of this is Alex Darwall, who runs Jupiter European Opportunities Trust, which has an ongoing charge plus performance fee of 2.5 per cent. He also runs Jupiter European Fund (GB00B5STJW84), which has a much more reasonable ongoing charge of 1.02 per cent because it doesn’t have a performance fee.

The two funds are not identical in terms of their holdings and asset allocation, but both mainly invest in European equities and are run according to the same strategy by Mr Darwall. So unless your investment platform makes it prohibitively expensive to hold open-ended funds, it is more cost effective to access this manager's stockpicking skills via Jupiter European Fund.

Another example is Lindsell Train Investment Trust (LTI), run by highly regarded manager Nick Train. This has a basic ongoing charge of 0.86 per cent, but when its performance fee is added on this rises to 2.9 per cent. And this trust is trading on an eye-watering premium to net asset value (NAV) of over 73 per cent. But Nick Train also runs Lindsell Train Global Equity Fund (IE00BJSPMJ28), which can be picked up for an ongoing charge of 0.51 per cent, or 0.71 per cent, depending on which platform you buy it from.

However, remember to calculate the total cost of investing in the fund, adding the ongoing charge and any performance fee to the costs of the investment platform you use.

If your platform means it is expensive for you to hold open-ended funds, in cases where your preferred investment trust has a very high charge, consider investing in another trust in its sector that does not charge as much.

No justification for a high charge

You might argue that an investment trust can use gearing – take on debt – to enhance returns, so it's worth paying more for one than an equivalent open-ended fund. But gearing may not enhance performance, while higher charges will certainly detract from your returns. And if a trust’s manager gets their selection wrong or markets are falling, a trust with gearing will experience bigger losses than a similar fund without. So, far from being an added bonus, the ability to gear can be very damaging to a trust and its shareholders’ returns.

Even though investment trusts can gear they might not gear, or certainly not all of the time. So check this, and don't invest in an expensive investment trust in the hope that gearing will get it higher returns than a cheaper open-ended equivalent, if it doesn't have any gearing.

If an investment trust does have gearing look at what it is paying for its debt. Even if its managers get their calls right and markets go up, if a trust is servicing expensive debt the costs will eat into its returns.

The ability to gear is not a fundamental reason to favour a trust over an alternative that is better in other ways, such as cost and performance.

It has also been argued that investment trusts are worth the extra cost because statistics show they have performed better. However, if they have much higher charges this extra performance may be eaten away. These figures also look at past performance and there is no guarantee that future performance will be as good. But high charges are a certainty, so holding an expensive trust in the hope of better performance is paying for something that may not happen.

If you invest in investment trusts you maybe enjoy playing discounts or premiums to NAV. But while buying a trust on a discount might seem like a bargain, if it has high charges this is a false economy. There is no guarantee that a discount will tighten or that a trust will perform well, but high charges most certainly will eat into its returns.

If you are upset at the idea of not investing in an investment trust ask yourself this: what do I want more – a type of fund structure, or making the best possible returns with my investments, and meeting my financial and life goals?

Cheap and awful

Don't invest in a trust just because it is the cheapest in its sector. You need to assess a number of things of which cost is one consideration – and not the most important one. Performance is a key attribute because there is no point in having low charges if a trust is underperforming or – even worse – losing your money.

Other things to look out for are a premium to NAV, because if this is high relative to the trust’s history it may not increase further and be set for a fall. Investing in a trust with a low charge trading on a high premium might also be a false economy.

Different types of investment trusts have different charges and, generally, trusts that invest in more esoteric, unlisted and illiquid assets have higher charges. This is partly because it is more expensive to buy, maintain and manage physical assets such as buildings or infrastructure projects. And the due diligence you need to do on unlisted companies, such as private equity trusts hold, is greater than what you need to do for a share listed on a major market. This can mean having more analysts spending time doing this, which pushes up costs.

Funds focused on niche areas are also likely to have fewer assets under management and smaller market capitalisations, meaning they have higher ongoing charges than large mainstream equities investment trusts and funds.

But you should still be discerning with regard to charges when investing in areas such as infrastructure, commercial property and private equity. Compare the charges and performance of these types of investment trusts with their AIC sector peers.

And with trusts that pay an income, look at what their record is of doing this to see what you are getting for your fees.