Ian Cowie: fund or trust, which is the fairest one of all?

There are 45 examples of funds and investment trusts sharing the same fund manager, so-called mirror funds. Which came out on top?

Mirror, mirror on the wall, which is the best type of collective investment or pooled fund of all? New analysis of unit and investment trusts, exclusively conducted for interactive investor readers, shows that apparently technical differences can have important practical effects on cash returns to unit-holders and shareholders.

Independent statisticians Morningstar track the performance of both types of pooled fund, including dozens that share the same individual manager and investment objectives. Because of their similarities, these are sometimes called ‘mirror funds’ and it is easy to see how their status - as unit or investment trusts - affects investor returns.

Before your eyes glaze over, I had better say straightaway that 82% of ‘mirror funds’ whose performance was measured over the last five years show investment trusts delivered higher returns than unit trusts. There are 45 examples where unit and investment trusts share the same fund manager and objectives, so this is a significant sample.

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Better still, there are big cash differences in returns to investors - even among some of the most successful fund management companies. For example, the unit trust, Baillie Gifford Global Discovery, turned £1,000 into £2,543 over the last five years. That’s an impressive return but not as impressive as its ‘mirror’ investment trust, Edinburgh Worldwide (LSE:EWI), which turned the same sum over the same period into £3,173.

Similarly, Baillie Gifford Japan Smaller Companies turned £1,000 of units into £1,776 over the last five years, while Baillie Gifford Shin Nippon (LSE:BGS) delivered £1,980 to shareholders. More dramatically, Baillie Gifford Pacific returned £2,727 while its investment trust ‘mirror fund’ Pacific Horizon (LSE:PHI) shot the lights out with £4,336.

Closer to home, BMO European Smaller Companies rewarded unit holders with a return of £1,693 while shareholders in the same company’s European Assets (LSE:EAT) received £1,897. On the same basis, unit holders in JPMorgan UK Smaller Companies bagged £1,991, but shareholders in JPMorgan UK Smaller Companies (LSE:JMI) did much better with £2,793.

Similar contrasts can be seen over the last 10 years, where there were 29 pairs of ‘mirror funds’ and investment trusts delivered the highest total returns 72% of the time.

So what’s going on? Why does one form of pooled fund do so much better than the other?

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Bear in mind that most of the business reporters I know would struggle to define the difference between unit and investment trusts, so it is worth getting technical.

Nick Britton, head of intermediary communications at the Association of Investment Companies (AIC), told me: “Investment companies often outperform due to structural advantages.

“These include the ability to borrow money to invest (known as gearing) and the fact that investment companies have a fixed pool of capital to invest, with no daily redemptions. That enables them to take a longer-term view of their investment portfolio, without any pressure to sell assets in tough market conditions, or buy assets in an overheated market.

“It also means they can invest in less liquid assets; so, for example, an investment company that specialises in smaller-company investing may allocate a larger portion of the portfolio to the smallest companies, which might perform better over time, while an open-ended equivalent might be forced to hold more in more liquid mid-cap companies to ensure it can meet redemption requests.”

To be fair, investment companies - also known as investment trusts - do not always beat unit trusts. For example, Polar Capital Technology (LSE:PCT) booted up £3,226 over the last five years but lagged behind Polar Capital Global Technology’s £3,673. However, this long-term shareholder is pleased to see Morningstar’s statistics show PCT still ahead over the last decade with £8,109 compared to its unit ‘mirror’ with £6,805.

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However, even over the longer term, unit trusts can and do win sometimes. For example, the unit trust LF Lindsell Train UK Equity beat its ‘mirror’ Finsbury Growth & Income (LSE:FGT) over both five and 10-year periods.

Britton pointed out: “Of course, investment companies won’t always outperform open-ended funds and will tend to do worse in down markets, especially if they use gearing.

“However, the ability to buy and sell assets when the manager feels the time is right, rather than being forced into purchases and sales at inopportune times because of fund flows, is hugely useful when trying to deliver excellent performance.”

Both forms of pooled fund automatically diminish risk by diversification and enable individual investors to share the cost of professional management, enabling us to gain exposure to economies far away and markets that trade while we sleep. But the devil is in the detail and apparently small differences between these types of funds can have big effects on investor returns.

Ian Cowie is a freelance contributor and not a direct employee of interactive investor. 

Ian Cowie is a shareholder in Baillie Gifford Shin Nippon (BGS) and Polar Capital Technology (PCT) as part of a diversified global portfolio of investment companies and other shares.