- As well as having plenty of pros, investment trusts also have cons of their own
- Where might other funds work better?
Investment trusts have long been a popular format with Investors' Chronicle readers, and for good reason. Portfolios such as Scottish Mortgage (SMT) have delivered good returns over the long run; trusts offer exposure to illiquid asset classes such as private equity; and they also offer all manner of additional tools, from revenue reserves to gearing. Trusts also enable a "purer" form of active management, including greater use of small-cap allocations, not least because they aren't subject to daily inflows and outflows which managers must incorporate into their strategy.
Having said that, those used to focusing on trusts over other funds should remember this is not always the best option. Trusts can come with plenty of drawbacks, which means open-ended funds do continue to stand out in a number of areas.
The simple life
Those accustomed to the complexities of investing may well take easily to trusts, but there are many details to understand. Trusts have to manage their levels of gearing, often deal with share price discounts to net asset value (NAV) and, in the case of those that pay dividends, keep an eye on their dividend cover and revenue reserves.
Open-ended funds lack such complications, even if they cannot benefit from the rewards that such tools can sometimes generate. Investors in such funds also have no need to worry about the actions of a board or the potential for merger and acquisition activity, albeit open-ended funds can still be closed or merged away at times.
Importantly, some investors might like the fact that open-ended funds can often come with lower volatility thanks to the fact that they make no use of gearing. The amplified nature of trust returns (both in good times and bad) has been evident, to some extent, in recent years.
To offer one example, the average fund in the (open-ended) UK All Companies sector lost 9.1 per cent in the bear market of 2022, much less than the 21.3 per cent loss for the average (closed-ended) AIC UK All Companies fund. And yet the average UK trust made a 10.5 per cent share price total return in 2023, outpacing the 7.4 per cent gain from the equivalent open-ended peer.
Much as volatility can often be a route to better long-term gains, this may be something that investors with a lower appetite to risk, or those such as retirees that can stomach less in the way of short-term losses, want to avoid.
"Investment trusts are prone to take the brunt of additional selling pressure in weak markets, which means the share price can fall more than the NAV," notes Charles Stanley chief analyst Rob Morgan.
"This can represent an opportunity to buy in for the long term, but for those that are closer to drawing on their investments, or are already doing so, then this can be unnerving and, in some cases damaging.
"Many in drawdown try to simply take the ‘natural income’ from their investments, using dividends and other income to fund their withdrawals, but where capital is drawn then anything that adds more volatility is unwelcome."
Sectors
Fans of the Fundsmith brand will be well aware that certain open-ended vehicles can offer returns that rival those of their closed-ended peers. On top of this, there are other areas where the latter can offer even better returns, or exposure not so widely available in the open-ended sector.
One of these is a once-dull space that has proved more appealing in the last two years: fixed income.
Some bond funds are available in the closed-ended universe, including the Invesco Bond Income Plus (BIPS) trust that focuses predominantly on high yield debt. However, those looking to buy into fixed income as an asset class have many other options. This can range from buying the likes of gilts directly (which can be done using platforms) to buying investment grade, high yield and strategic bond funds. This trio of options all tend to be structured as open-ended funds, with the first two being available in both an active and passive format.
"Fixed interest is an area where you don’t have much choice in the investment trust landscape, and I think there is good reason for that," Morgan notes.
"Bond investors generally want a steady income and to control volatility, so that really means funds are more of a suitable vehicle. The last thing you want is for your positions in diversifying or balancing assets to have the extra risk and volatility associated with being exchange traded with a variable premium or discount to NAV."
Looking across all asset classes, there are thousands of open-ended funds available, as well as hundreds of investment trusts. As such it can be worth not writing off either option when trying to choose the best vehicle, even if each comes with its own quirks.
Investors looking to invest in similar asset classes using different structures should note that the results will likely be different depending on which they choose. An investment trust holding physical property assets will likely be more vulnerable to moves in bond yields, but less exposed to equity market volatility, than an open-ended fund that buys shares in listed infrastructure companies, to give one example.
The open-ended route can bring much more choice in some areas. Morgan, for one, believes that this does apply in one of the most efficient markets. "US equities is one area where there is a curious lack of options in the investment trust world, for instance, whereas there are plenty of funds to choose from investing in both large companies and further down the market cap spectrum," he says.
This argument could also apply elsewhere: the AIC UK All Companies sector contains just seven funds, while the equivalent IA sector contains more than 230 options.
The disruptive element
From Nick Train to a variety of Baillie Gifford managers, there are many renowned professional investors who run both an open-ended fund and a similar closed-ended option.
In recent times investors have been able to get "cheap" exposure to such teams thanks to the discounts on which investment trusts have traded, for instance Finsbury Growth & Income (FGT), Scottish Mortgage or Temple Bar (TMPL).
However investors may well prefer the open-ended versions, because of the fact they avoid many of the corporate actions that discounts can usher in, be that acquisition activity, the emergence of activist investors, or broader concerns about the perceived need for a trust to address and resolve that discount.
In short, whether investors can tolerate greater uncertainty in return for potentially bigger gains can often dictate their choice of investment vehicle.
