When to look past investment trusts

Our latest ii Top 50 Fund Index, showcasing the portfolios favoured by our customers, indicates that appetite for investment trusts remains strong. 

They represent around a fifth of the most popular funds in the last quarter, with names such as Scottish Mortgage Ord (LSE:SMT), City of London Ord (LSE:CTY) and Seraphim Space Investment Trust Ord (LSE:SSIT) pulling in the punters. 

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That partly reflects their individual qualities, from SMT and Seraphim’s focus on exciting themes to CTY’s lengthy record of dividend increases. But the advantages of trusts more generally remain pretty compelling.

In short, they can give investors a punchier option than an open-ended fund but with more potential upside.  

An investment trust manager can often take more concentrated positions than in an open-ended fund, use gearing to potentially amplify returns, and hold back revenue reserves to shore up their dividend payments if they have an income focus. 

And as we discuss in our weekly Discount Delver feature, trust shares give you a potential bargain when they trade below the stated portfolio net asset value (NAV). 

If all of this is appealing enough, it’s worth remembering that investment trusts are not the best fit for everyone. There are numerous instances where you may be better off going with an open-ended fund instead. 

Keeping a lid on risk 

We’ve noted that trusts can offer a punchier form of market exposure than open-ended funds, but this might not be for everyone. Those who are already in retirement, or who struggle with the ups and downs of markets, may wish to limit their volatility by using open-ended funds where applicable. 

While trusts are best suited for holding illiquid assets such as private equity and infrastructure, equities can easily be held in the open-ended structure. And trusts operating in the equity space face plenty of competition from the open-ended space. 

It’s worth remembering that some prominent equity trusts even have “sibling” funds, which are run by the same investment team and with a similar approach. 

The examples here include Alex Wright’s Fidelity Special Situations W Acc, the TM Redwheel UK Eq Inc R Inc fund run by the Temple Bar Ord (LSE:TMPL) team, and WS Lindsell Train UK Equity Acc with Finsbury Growth & Income Ord (LSE:FGT).  

But this isn’t just a UK story: many of the trusts managed by Baillie Gifford have open-ended siblings, as do well-known trusts such as Templeton Emerging Mkts Invmt Tr TEMIT (LSE:TEM), Henderson Far East Income Ord (LSE:HFEL) and BlackRock World Mining Trust Ord (LSE:BRWM). 

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For the time being the trusts do look better by total returns. Data from the Association of Investment Companies (AIC), which is admittedly keen to champion trusts, shows that, of 50 pairings of trusts and “sibling” open-ended funds, 41 of the trusts outperformed over a 12-month period. 

But it’s worth remembering that trusts will be more volatile when markets fall out of bed. Such jolts are illustrated by the fact that a lower 25 of 47 trusts outperformed the open-ended equivalent over a five-year period. 

To give some examples of trusts handsomely outperforming in recent times, in the Baillie Gifford stable Pacific Horizon Ord (LSE:PHI) is well ahead of Baillie Gifford Pacific B Acc over 12 months, while in the UK small-cap space Strategic Equity Capital Ord (LSE:SEC) has done much better than WS Gresham House UK Smaller Coms C Acc. 

But the trusts can suffer much greater pain when markets struggle. This was amply demonstrated in 2022, when the Baillie Gifford Pacific fund lost 20.2% but the Pacific Horizon trust lost 32.5%. While both are hefty losses in their own right, some investors may need to limit the damage with the less volatile option. 

Investors do, however, need to remember that sometimes the “siblings” are actually very different. This does apply to some Baillie Gifford examples, with names such as Edinburgh Worldwide Ord (LSE:EWI) able to hold private companies but open-ended siblings such as Baillie Gifford Global Discovery B Acc unable to do so. 

Remembering the open-ended outperformers

There are some instances where open-ended funds have actually tended to beat the investment trust equivalent. Investors will also occasionally come across open-ended funds offering something not available in the investment trust sector. 

Oddly enough, all the examples here are portfolios managed by Polar Capital. 

The AIC analysis referenced earlier shows that Polar Capital Healthcare Opps I Acc has significantly outperformed Polar Capital Glb Healthcare Ord (LSE:PCGH) over 12 months, with Polar Capital Global Tech R Inc GBP well ahead of the widely followed Polar Capital Technology Ord (LSE:PCT) trust. 

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The fund firm also runs the Polar Capital Global Ins I Acc fund, which has a good track record of absolute performance and of behaving very differently to the global stock market over time. Such a portfolio is not available in a closed-ended format. 

Valuations, volatility and hassle 

A few other considerations might drive investors to back an open-ended fund over a trust. 

Sticking with the so-called sibling funds, there is the idea that you would back the trust when its shares are heavily discounted but use the fund if the shares command a premium.

Such thinking could apply to Temple Bar (on a 1% premium) and to Henderson Far East Income (3.5%). 

Investors might also pay attention to whether a trust is running a high level of gearing, and whether they want to take that heightened level of risk. 

Beyond that they might wish to avoid trusts at risk of drama or consolidation. There are especially small trusts like BlackRock Income and Growth Ord (LSE:BRIG) and those known as Saba targets, for one.  

However, the share price boost that can arrive when a trust does get bought out might justify the hassle of having to find a new home for your cash.