We compare the performance of 10 managers running an investment trust and a fund using a similar strategy.
It is widely accepted that the use of ‘gearing’, borrowing to invest, is a key advantage investment trusts have in their armoury and it can enhance shareholder returns over the long term. But when markets are volatile, gearing has the reverse effect as losses are magnified (a more detailed explanation of gearing is provided at the bottom of this article).
Research by interactive investor shows that the Covid-19 market sell-off hammers this point home. Using data from FE Analytics, we compared the performance of 10 “pair portfolios” of funds and comparable investment trusts run by the same manager using a similar strategy.
We looked at four time periods to 16 August 2021: the sell-off in the first quarter of 2020; the market recovery phase (from 1 April 2020 onwards); since the start of 2020 (incorporating both the sell-off and the recovery); and over the past five years.
Our research found that in two of the four periods most of the fund ‘pairs’ outperformed, with the key reason being the negative impact gearing has in a falling market for investment trusts. In addition, when there’s a sell-off, investment trusts tend to fall to sizeable discounts, which results in the share price losing more value than the underlying assets.
Investment trusts have two values: the amount the trust itself is worth (the net asset value or NAV), and its share price. Trusts trade on either a premium or a discount. A more comprehensive explanation can be found below in our video and in our written guide to investment trusts.
The 10 funds and trusts (funds are listed first) run by the same manager we selected were:
- Alex Wright: (Fidelity Special Situations and Fidelity Special Values (LSE:FSV)
- Douglas Brodie: (Baillie Gifford Global Discovery and Edinburgh Worldwide (LSE:EWI)
- Francesco Conte and Edward Greaves: (JPM Europe Smaller Companies and JPM European Discovery Trust (LSE:JEDT)
- Francis Brooke and Hugo Ure: Troy Trojan Income and Troy Income & Growth (LSE:TIGT)
- Harry Nimmo: ASI UK Smaller Companies and Standard Life UK Smaller Companies (LSE:SLS)
- John Bennett: Janus Henderson European Focus and Henderson European Focus Trust (LSE:HEFT)
- Neil Hermon: Janus Henderson UK Smaller Companies and Henderson Smaller Companies Trust (LSE:HSL)
- Nick Train: Lindsell Train UK Equity and Finsbury Growth & Income (LSE:FGT).
- Samuel Morse: Fidelity European and Fidelity European Trust (LSE:FEV).
- Simon Gergel: Allianz UK Listed Equity Income and Merchants Trust (LSE:MRCH).
All performance figures quoted below are total return, share price total return in the case of investment trusts.
It is also worth pointing out that while each pair portfolio is run by the same manager following a similar strategy, some will have more overlap in terms of their holdings than others.
The Covid-19 market sell-off in first quarter of 2020
As expected in a falling market, a period in which the MSCI World index fell by 15.7% and the FTSE All-Share index by 25.1%, most of the funds held up better than their investment trust equivalents.
In total, eight of the 10 funds posted smaller losses. The most sizeable difference was JPM Europe Smaller Companies and JPM European Discovery Trust. The fund fell by 22.1% compared to the 34.3% share price loss for the investment trust. There were also notable gaps between the funds and trusts run by Harry Nimmo and John Bennett.
For most of the other pairs, it was a closer run race. The outliers were Troy Income & Growth and Finsbury Growth & Income, which both slightly outperformed their open-ended fund versions. Troy Income & Growth does not use gearing, while Finsbury Growth & Income runs very low gearing levels. In addition, the boards of both trusts actively buy back shares to avoid trading on a notable premium or discount.
The main reason for the other eight trusts lagging in a falling market is due to gearing. Widening discounts over this period will also not have helped.
|Fund||Investment trust||Fund performance in first quarter of 2020 (%)||Trust performance in first quarter of 2020 (%)||Which outperformed?|
|Fidelity Special Situations||Fidelity Special Values||-34.1||-38.5||Fund|
|Baillie Gifford Global Discovery||Edinburgh Worldwide||-6.1||-8.6||Fund|
|JPM Europe Smaller Companies||JPM European Discovery Trust||-22.1||-34.3||Fund|
|Troy Trojan Income||Troy Income & Growth||-18.8||-16.6||Trust|
|ASI UK Smaller Companies||Standard Life UK Smaller Companies||-25.5||-31.4||Fund|
|Janus Henderson European Focus||Henderson European Focus Trust||-18.1||-26.5||Fund|
|Janus Henderson UK Smaller Companies||Henderson Smaller Companies Trust||-31.8||-36.4||Fund|
|Lindsell Train UK Equity||Finsbury Growth & Income||-15.9||-15.6||Trust|
|Fidelity European||Fidelity European Trust||-13||-15.3||Fund|
|Allianz UK Listed Equity Income||Merchants Trust||-30.6||-33||Fund|
Performance period: 1 Jan 2020 to 31 Mar 2020. Source: FE Analytics.
Market recovery phase from last April onwards
In a rising market, gearing has turbocharged returns for most of the 10 trusts. In three cases, the difference is more than 10% for investment trusts managed by Francesco Conte and Edward Greaves, Alex Wright and Harry Nimmo.
Gearing has, therefore, paid off in most cases. In addition, discounts narrowing over this time period will have provided a performance boost.
The two outliers are Troy Trojan Income and Lindsell Train UK Equity. Both outperformed their investment trust equivalents. As mentioned above, Troy Trojan Income does not use gearing, while Finsbury Growth & Income has a very low gearing level, currently around 1%.
|Fund||Investment trust||Fund performance since April 2020 (%)||Trust performance since April 2020 (%)||Which outperformed?|
|Fidelity Special Situations||Fidelity Special Values||68.8||84.5||Trust|
|Baillie Gifford Global Discovery||Edinburgh Worldwide||79.1||79.4||Trust|
|JPM Europe Smaller Companies||JPM European Discovery Trust||90.5||123.9||Trust|
|Troy Trojan Income||Troy Income & Growth||24.6||19.5||Fund|
|ASI UK Smaller Companies||Standard Life UK Smaller Companies Trust||74||89.3||Trust|
|Janus Henderson European Focus||Henderson European Focus Trust||60.2||66.6||Trust|
|Janus Henderson UK Smaller Companies||Henderson Smaller Companies Trust||95.9||104.9||Trust|
|Lindsell Train UK Equity||Finsbury Growth & Income||33.2||30.1||Fund|
|Fidelity European||Fidelity European Trust||48.1||57.1||Trust|
|Allianz UK Listed Equity Income||Merchants Trust||63.8||64.2||Trust|
Performance period: 1 Apr 2020 to 16 Aug 2021. Source: FE Analytics.
Since the start of 2020 (incorporating both the sell-off and the recovery)
When both the sell-off and the recovery periods are combined – through assessing performance since the start of 2020 – funds have outperformed trusts for eight of the 10 pairs.
This shows the negative impact gearing can have when stock markets have a sizeable sell-off, which played out in the first three months of 2020.
The two trusts that bucked the trend were Fidelity Special Values and Fidelity European Trust. In both cases, the fund managers increased gearing as markets recovered, which paid off.
In Fidelity Special Values’ half-year report the trust noted, “as the company had increased gearing and the market rose in the review period, the use of derivatives was a significant contributor to performance”. The report was published earlier this year, covering the six-month period to the end of February.
In addition, in Fidelity European Trust’s more recently published half-year report, for the period to the end of June, the trust said that “increased gearing of the company was a significant contributor to performance”.
|Fund||Investment trust||Fund performance since start of 2020 (%)||Trust performance since start of 2020 (%)||Which outperformed?|
|Fidelity Special Situations||Fidelity Special Values||7.4||13||Trust|
|Baillie Gifford Global Discovery||Edinburgh Worldwide||61.4||59.3||Fund|
|JPM Europe Smaller Companies||JPM European Discovery Trust||45.3||43||Fund|
|Troy Trojan Income||Troy Income & Growth||-0.9||-3.1||Fund|
|ASI UK Smaller Companies||Standard Life UK Smaller Companies Trust||26.5||20.7||Fund|
|Janus Henderson European Focus||Henderson European Focus Trust||27.7||23.2||Fund|
|Janus Henderson UK Smaller Companies||Henderson Smaller Companies Trust||30.8||24.3||Fund|
|Lindsell Train UK Equity||Finsbury Growth & Income||7.5||5.5||Fund|
|Fidelity European||Fidelity European Trust||25.6||29.7||Trust|
|Allianz UK Listed Equity Income||Merchants Trust||10.3||7.6||Fund|
Performance period: 1 Jan 2020 to 16 Aug 2021. Source: FE Analytics.
Over five years, trusts have upper hand
Over a longer time period of five years, the trusts outperformed nine times out of 10.
In two cases the difference in returns is significant; Edinburgh Worldwide returned 218.5% versus 169% for Baillie Gifford Global Discovery, while Henderson Smaller Companies Trust is up 147.3% against 104.4% for Janus Henderson UK Smaller Companies.
The exception is Lindsell Train UK Equity, which narrowly outperformed Finsbury Growth & Income, with a return of 55.1% versus 53.4%.
Over the five-year period, despite not gearing, Troy Income & Growth Trust had a slight edge on Trojan Income, with returns of 18.8% and 16.8% respectively. Given the trust tends to trade around par (due to regularly buying back its own shares), this will have been mainly driven by the performance of its underlying investments, which over the time period has given the trust the upper hand over the fund.
Overall, the data shows that investment trusts' ability to gear will, during a market sell-off, impact short-term performance, but that it can be beneficial over a longer time frame.
|Fund||Investment trust||Fund performance over five years (%)||Trust performance over five years (%)||Which outperformed?|
|Fidelity Special Situations||Fidelity Special Values||40.9||74.6||Trust|
|Baillie Gifford Global Discovery||Edinburgh Worldwide||169||218.5||Trust|
|JPM Europe Smaller Companies||JPM European Discovery Trust||84.7||90.4||Trust|
|Troy Trojan Income||Troy Income & Growth||16.8||18.8||Trust|
|ASI UK Smaller Companies||Standard Life UK Smaller Companies Trust||125.5||132.3||Trust|
|Janus Henderson European Focus||Henderson European Focus Trust||68.2||76.5||Trust|
|Janus Henderson UK Smaller Companies||Henderson Smaller Companies Trust||104.4||147.3||Trust|
|Lindsell Train UK Equity||Finsbury Growth & Income||55.1||53.4||Fund|
|Fidelity European||Fidelity European Trust||77.9||104.4||Trust|
|Allianz UK Listed Equity Income||Merchants Trust||54.3||64.3||Trust|
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.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.