Funds have the upper hand in short-term performance, but investment trusts could make better long-term investments, writes Sam Benstead.
Scottish investment giant Baillie Gifford stands out for lots of reasons.
It is a partnership, meaning that there is no pressure to answer to outside shareholders, unlike listed peers such as Jupiter, Liontrust, or Schroders. It is also known for a single investment style: growth investing, although it is more diversified as a fund manager than many think.
Another key characteristic is that fees are low for a group that offers only active funds, with its flagship investment trust Scottish Mortgage (LSE:SMT) charging just 0.32% a year in management fees.
But an overlooked part of its business model is that it aims to offer investors a choice of an open-ended fund or investment trust for each of its flagship portfolios. It has 12 pairs of funds and investment trusts, normally run by the same teams, with the same investment approach.
Investment trusts have a fixed number of shares, which are traded on the stock market. The share price can diverge from the underlying value of the assets, or net asset value (NAV), leading to discounts or premiums appearing. This makes them more suitable for holding private companies, as the fund manager does not have to sell parts of their portfolio to meet withdrawal requests.
Trusts can also borrow, also known as gearing, which supercharges returns as well as losses.
On the other hand, open-ended funds value their portfolio once a day and investors buy and sell fund units at a set price. New units are created and sold when trades take place, meaning that a fund grows or shrinks when money flows in and out. Redemption requests are met by selling assets or paid out of cash held by a fund.
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Over 20 years, interactive investor research, with data to July 2022, showed that investment trusts have been better performers than funds. Apart from the UK Smaller Companies sector, where funds have outperformed, trusts on average, beat their fund counterparts across every other comparable fund sector which ii looked at.
However, separate new research on Baillie Gifford pairs tells a different story. Of the 12 pairs, total return data available on FE FundInfo, starting only when Baillie Gifford took over as manager of the investment trust and when there was a comparable fund, showed that funds outperformed the mirror trusts on seven of the 12 pairs.
How the fund and trust pairs performed
Baillie Gifford’s flagship growth investment trust Scottish Mortgage, which has a market value of around £9.5 billion, has actually underperformed its open-ended sister fund - Baillie Gifford Long Term Global Growth - since it was launched in April 2017.
Baillie Gifford Long Term Global Growth has returned 127.9% since launch compared with 85.4% for Scottish Mortgage. It has a different management team to Scottish Mortgage, as well as some key differences in its top 10 positions. For example, the fund has Nvidia as its top stock, at 6%, which has increased more than 150% in value this year, while the trust has just 3% in Nvidia.
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Baillie Gifford American has returned 64.4% since trust rival Baillie Gifford US Growth was launched in March 2018, returning 44.5%, while Baillie Gifford Positive Change has outperformed trust rival Keystone Positive Change since its takeover by Baillie Gifford in February 2021 (-2.7% for the fund versus –5.7% for the trust).
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Baillie Gifford Shin Nippon is up 290% since September 1999 compared with 202.3% for Baillie Gifford Japanese Smaller Companies, while Scottish American is up 323% compared with 282% for the Global Income Growth fund since it was launched in March 2010.
Source: FE Fund Info, total return % data to 30 May 2023. Past performance is not a guide to future performance.
Why has performance been different?
Generally, shorter comparison records favour funds. This is because investment trust discounts have widened over the past two years, as sentiment towards technology and other growth stocks soured.
Baillie Gifford trusts have been in the firing line more than most due to their investments in unlisted shares, where the valuation depends on the views of investment consultants instead of market prices.
The valuations of private companies have stayed relatively resilient compared with public companies, and therefore shareholders have reacted by selling trust shares to create a discount between the share price and the NAV.
For example, Scottish Mortgage has 30% in unquoted stocks and trades at 20% discount, while Baillie Gifford US Growth Trust is on a 22.5% discount and has 38% in private companies. Edinburgh Worldwide has 18.7% in private companies and is on a 18.4% discount, Pacific Horizon is at a 9.8% discount and has 5.1% in unquoted stocks, and Keystone Positive Change is at 17.5% discount with 4.8% in private stocks.
Gearing is also a factor behind the recent underperformance of investment trusts managed by Baillie Gifford. Borrowing money to buy shares means that trusts are more exposed to stock market swings than their open-ended peers.
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For example, Scottish Mortgage is 15% geared and Edinburgh Worldwide is 12% geared, meaning that their investments are 15% and 12% larger than they would be without leverage.
This means that down markets affect them more, but over the long term – because stock markets tend to rise – they perform better. This has helped trusts beat their fund pairs at Baillie Gifford over longer time horizons.
James Budden, director at Baillie Gifford, says that the main differences are that the investment trusts can use gearing and invest in less liquid public stocks and also private companies.
Alex Watts, fund analyst at interactive investor, adds that Baillie Gifford’s trusts are higher risk than their fund peers, which explains the short-term volatility.
“They own unlisted shares, which are often earlier-stage businesses. What is more, these companies can be trickier to sell than listed companies and can also present challenges in valuation,” he said.
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However, Watts says that such companies bring greater potential for earnings and valuation growth if Baillie Gifford is able to successfully find the next generation of winning companies, but there is no guarantee that will happen.
He said: “Scottish Mortgage is a member of our Super 60 list, in the ‘adventurous’ category. The trust has an allocation of near 30% to unlisted companies, a number of which are later stage, which are revalued on a regular basis. While it has underperformed its open-ended sister fund recently, we believe that access to unlisted companies can be a consideration for those long-term investors, with appropriate risk appetite, looking to own exciting growth companies from around the world.
“Investment trusts, due to their shares being listed and gearing, are also more volatile than open-ended funds, so are less suitable for investors with short time horizons, especially given the nature of the companies that Baillie Gifford invests in.”
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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.