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Why do investment trusts perform better than open-ended funds?


Recent by a UK wealth management group shows investment trusts consistently outperform similar “sister funds”. On an underlying basis – excluding movements in discounts/premiums – investment trusts have been even better, delivering 5.3% of additional return, with 75% of trusts outperforming.

Dating back to 1868, investment trusts are the older sibling of the modern fund. Like many older siblings, they’re also serial outperformers. Investment trusts let you invest in things like private equity and infrastructure, that are otherwise the preserve of institutions and the mega wealthy, and can even give you an edge when it comes to conventional stocks and shares.

“Our research shows investment trusts tend to outperform open-ended funds from the same manager, following the same strategy,” Nicholas Hyett, Investment Manager at Wealth Club, commented. “In some cases investment trusts have delivered 50 percentage points or more in additional return over ten years – benefiting from gearing, reduced liquidity concerns and the opportunity to buyback their own shares.”

Their younger sibling, the open-ended fund, might be easier to get on with, and less volatile, but for the patient investor who can look through the stock market’s ups and downs, the extra returns on offer from investment trusts should not be ignored.

Investment trusts – the outperforming sibling

Wealth Club looked at NAV total return across c.80 investment trust/sister fund pairs. For the purposes of this study they classed “sister funds” as funds following the same, or a very similar strategy, as an investment trust, that are managed by the same named manager or team.

On an underlying net asset value (NAV) basis the average investment trust outperformed its sister fund by 5.3%, over ten years, with 75% of trusts doing better than their siblings.

excess returns

1yr 5yr 10yr
Average excess return for investment trusts vs sister fund 1.9% 2.7% 5.3%
Percentage of investment trusts that outperform their sister funds 44.4% 67.2% 75.0

Of course, the thing about investment trusts is that your return isn’t entirely down to NAV growth. It’s affected by movements in the discount or premium of the share price too. Recently discounts have not moved in investment trusts’ favour, widening considerably. This means while investment trusts have still performed well, share price returns haven’t been quite as strong as NAV returns.

excess returns 1, 5, 10 years

The good news is that this discount/premium effect diminishes over time, with NAV return an increasingly important role in determining returns over the long term. Investors can also benefit when discounts close, or trusts rise to a premium. Put that together with a stronger NAV return and the returns are potentially significant.

Standout performers

In some cases the gap between the investment trust and sister fund performance is considerable. The five strongest outperformers delivered an average of 59.6 percentage points more than their open ended alternatives.

Excess return over sister fund over 10 years
Montanaro European Smaller Ord 106.6%
JPMorgan UK Small Cap Growth & Income 53.2%
Schroder Asian Total Return Inv. Company 47.9%
Fidelity European Trust Ord 46.3%
Middlefield Canadian Income Ord 43.9%

Why do investment Trusts perform better?

There are three key reasons why investment trusts can outperform open ended funds following the same strategy over the long term. They are:

Use of leverage

Investment trusts, as stock market listed companies, are able to borrow money. This is used to invest in more stocks, improving the trust’s performance over the long term – assuming of course that the return on the investment exceeds the interest on the debt.

Reduced liquidity concerns

Investment trusts are permanent capital vehicles. Investors can sell shares in the trust, but they can’t withdraw money from the fund itself.

Not having to worry about meeting investor redemption requests at short notice means that investors can take positions in small illiquid companies they might otherwise avoid. A wider opportunity set, together with the ability to harvest the premium that is usually associated with illiquid stocks, has the potential to boost returns over the long term.

Ability to buy back shares

One of the hazards with investment trusts is that the shares can trade at a discount to Net Asset Value (NAV). However, that creates an opportunity for the trusts themselves. Buying back their own shares at a sizeable discount to NAV locks in gains for investors at minimal risk.

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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