We compare performance data for 10 managers running an investment trust and a fund using a similar strategy.
Market volatility in the first quarter of 2020 serves as a reminder to investors that while investment trusts’ ability to gear can be advantageous to investors, it can magnify losses in times of heightened market volatility.
Research by interactive investor, using data from FE Analytics, compared the performance of 10 “mirror portfolios” of funds and comparable investment trusts run by the same manager using a similar strategy.
The numbers were crunched for 2020 year-to-date (to 23 July), for five years and for 10 years. We selected six UK mirror portfolios, one global and three European funds. A mixture of styles and strategy were chosen.
The data revealed that, year-to-date, funds managed to limit losses much better than their investment trust equivalents. As the table below shows, for nine of the 10 mirror portfolios the fund version outperformed.
|Funds and trusts run by the same fund manager|
|Fund manager||Fund name||Investment trust name|
|Alex Wright||Fidelity Special Situations||Fidelity Special Values (LSE:FSV)|
|Douglas Brodie||Baillie Gifford Global Discovery||Edinburgh Worldwide (LSE:EWI)|
|Francesco Conte, Edward Greaves||JPM Europe Smaller Companies||JPMorgan European Smaller Comp (LSE:JESC)|
|Francis Brooke, Hugo Ure||Troy Trojan Income||Troy Income & Growth (LSE:TIGT)|
|Harry Nimmo||ASI UK Smaller Companies||Standard Life UK Smaller Companies (LSE:SLS)|
|John Bennett||Janus Henderson European Focus||Henderson European Focus Trust (LSE:HEFT)|
|Neil Hermon||Janus Henderson UK Smaller Companies||Henderson Smaller Companies (LSE:HSL)|
|Nick Train||LF Lindsell Train UK Equity||Finsbury Growth & Income (LSE:FGT)|
|Samuel Morse||Fidelity European||Fidelity European Values (LSE:FEV)|
|Simon Gergel||Allianz UK Equity Income||Merchants Trust (LSE:MRCH)|
For five of the 10 mirror portfolios, the investment trust has underperformed the fund by around 10%: Fidelity Special Values investment trust (LSE:FSV) versus Fidelity Special Situations (-33% versus -23.4%); Standard Life UK Smaller Companies investment trust versus ASI UK Smaller Companies (-23.2% versus -11.4%); Janus Henderson European Focus investment trust versus Janus Henderson European Focus Trust (-8.4% versus 4.1%); Merchants Trust (LSE:MRCH) versus Allianz UK Equity Income (-34.4% versus -22.7%).
But for the other five mirror portfolios the performance numbers are much closer, and in some cases the performance is virtually identical.
The key reason why funds managed to outperform trusts over the period is the fact that trusts may use gearing (borrowing to invest).
|In 2020 so far: funds versus trusts|
|Fund name||Investment trust name||Fund performance in 2020 (%)*||Trust performance in 2020 (%)||Which outpeformed?|
|Fidelity Special Situations||Fidelity Special Values (LSE:FSV)||-23.4||-33||Fund|
|Baillie Gifford Global Discovery||Edinburgh Worldwide (LSE:EWI)||43.6||41.8||Fund|
|JPM Europe Smaller Companies||JPMorgan European Smaller Companies Trust (LSE:JESC)||8.1||-1||Fund|
|Troy Trojan Income||Troy Income & Growth (LSE:TIGT)||-11.3||-13.7||Fund|
|ASI UK Smaller Companies||Standard Life UK Smaller Companies (LSE:SLS)||-11.4||-23.2||Fund|
|Janus Henderson European Focus||Henderson European Focus Trust (LSE:HEFT)||4.1||-8.4||Fund|
|Janus Henderson UK Smaller Companies||Henderson Smaller Companies (LSE:HSL)||-17.8||-30.7||Fund|
|LF Lindsell Train UK Equity||Finsbury Growth & Income (LSE:FGT)||-6.1||-5.2||Trust|
|Fidelity European||Fidelity European Values (LSE:FEV)||7.8||6.3||Fund|
|Allianz UK Equity Income||Merchants Trust (LSE:MRCH)||-22.7||-34.4||Fund|
|* To 23 July 2020. Source: FE Analytics.|
The use of gearing to enhance returns over the long term is an advantage for investment trusts – providing the trust’s underlying investments increase in value. But when markets fall heavily, gearing has the reverse effect: investors will suffer greater losses per share (see below for a more detailed explanation).
While on the whole investment trust gearing levels heading into the market sell-off in the first quarter of 2020 were modest: typically around 5%, according to research in April from investment trust analyst Winterflood, when it comes to comparison of similarly managed funds and trusts, gearing meant trusts displayed higher levels of volatility when markets fell out of bed.
Ben Yearsley, a director at Shore Financial Planning, notes: “In falling markets the impact of gearing in investment trusts, even a small amount, will often lead to underperformance. So short-term falls will impact near-term performance but will have less of an impact on longer-term numbers.
“Over the long term, I would expect a trust to outperform a similar fund if there is gearing.”
When comparing the performances of the mirror portfolios over the past five years, funds came out on top on eight of the 10 occasions – although in the majority of cases there was not much in it, as the table shows.
Five pairs with similar performance are: Finsbury Growth & Income (LSE:FGT) versus LF Lindsell Train UK Equity (57.1% versus 54.6%); Troy Income & Growth (LSE:TIGT) versus Troy Trojan Income (18.3% versus 18.8%); Fidelity Special Values (LSE:FSV) versus Fidelity Special Situations (-0.2% versus 4.7%); Fidelity European Values (LSE:FEV) versus Fidelity European (67.6% versus 72%); and Standard Life UK Smaller Companies (LSE:SLS) versus ASI UK Smaller Companies (64.8% versus 73.8%).
|Over five years: funds versus trusts|
|Fund name||Investment trust name||Fund performance over five years (%)*||Trust performance over five years (%)||Which outpeformed?|
|Fidelity Special Situations||Fidelity Special Values (LSE:FSV)||4.7||-0.2||Fund|
|Baillie Gifford Global Discovery||Edinburgh Worldwide (LSE:EWI)||168.4||180.6||Trust|
|JPM Europe Smaller Companies||JPM Europe Smaller Companies||82.5||58.6||Fund|
|Troy Trojan Income||Troy Income & Growth (LSE:TIGT)||18.8||18.3||Fund|
|ASI UK Smaller Companies||Standard Life UK Smaller Companies (LSE:SLS)||73.8||64.8||Fund|
|Janus Henderson European Focus||Henderson European Focus Trust (LSE:HEFT)||50||28.5||Fund|
|Janus Henderson UK Smaller Companies||Henderson Smaller Companies (LSE:HSL)||31.5||26||Fund|
|LF Lindsell Train UK Equity||Finsbury Growth & Income (LSE:FGT)||54.6||57.1||Trust|
|Fidelity European||Fidelity European Values (LSE:FEV)||72||67.6||Fund|
|Allianz UK Equity Income||Merchants Trust (LSE:MRCH)||8.5||-1.9||Fund|
|* To 23 July 2020. Source: FE Analytics.|
The severity of the stock market sell-off over a five-week period in February and March has played a major role in the performance of most funds that have outperformed comparable trusts.
When re-running the five-year performance numbers prior to the sell-off (from 1 February 2015 to 1 February 2020) nine of the 10 investment trusts performed better than the fund version. The only exception was Henderson European Focus Trust (LSE:HEFT), which lagged Janus Henderson European Focus (41.5% versus 48.3%).
When looking at a longer time period of 10 years, a period that for the most part (prior to the coronavirus sell-off) was the longest bull market in history for equities, investment trusts have the edge, outperforming six times out of 10.
The four exceptions are: Edinburgh Worldwide investment trust versus Baillie Gifford Global Discovery (481% versus 572%); Henderson European Focus Trust (LSE:HEFT) versus Janus Henderson European Focus (188% versus 196%); Merchants Trust (LSE:MRCH) versus Allianz UK Equity Income(71% versus 80%); and Troy Income & Growth (LSE:TIGT) versus Troy Trojan Income (120% versus 122%).
In the case of Edinburgh Investment (LSE:EDIN), it should be pointed out that it was not until January 2014 that Douglas Brodie took over management of the trust, so therefore the trust has not been following the same strategy and approach for the full 10 years. Brodie has managed Baillie Gifford Global Discovery since May 2011.
It is also worth bearing in mind that while each mirror portfolio is run by the same manager following a similar strategy, some will have more overlap in terms of their holdings than others.
For two of the mirror portfolios, the investment trust outperformance is notable: Henderson Smaller Companies Trust versus Janus Henderson UK Smaller Companies (358% versus 275%); and Finsbury Growth & Income investment trust versus Lindsell Train UK Equity (347% versus 291%) Lindsell Train UK Equity.
Therefore, over the past decade, the use of gearing to take tactical advantage of opportunities has paid off.
In addition, investment trusts’ closed-ended structure means they have a fixed number of shares that are traded on the stock market, rather than having to create or redeem “units” of investment in the fund as investor demand fluctuates. That, in turn, allows investment trust managers to focus on longer-term stock picks rather than being distracted by the short-term noise of investor withdrawals.
What is gearing?
Investment trusts are allowed to gear, or borrow, to invest. This can improve their performance, but it means they tend to be more volatile than their open-ended peers. Gearing in a rising market magnifies gains for each shareholder; but if the market falls, investors in a geared trust will suffer greater losses per share.
Simply put, if the manager borrows X to invest and the trust grows, the manager has to repay X plus interest, but retains the investment growth as part of the trust’s net asset value. So, if you have £1,000 invested (let’s assume a constant share price for now) and the manager gears by 10%, then there is effectively £1,100 working for you.
Now, if that doubles in value to £2,200, the manager pays back the £100 plus, let’s say, 1% interest. That leaves you – the investor – with £2,099. If the manager had not geared, you would have only £2,000.
Conversely, if the same investment halves in value to £550, the manager still has to pay back £101. This magnifies the losses, leaving you with only £449 instead of the £500 you would have without gearing.
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