Why I prefer trusts
Ian Cowie explains the outperformance of investment trusts
It is never difficult to distinguish between a Scotsman with a grievance and a ray of sunshine, said the English comic writer PG Wodehouse. Baillie Gifford, the great Edinburgh-based fund manager, has more reason than most to feel aggrieved after its high-flying fund, Edinburgh Worldwide Investment Trust (stock market ticker: EWI) fell victim to a hostile takeover bid by American arbitrageurs last month.
That drama was well covered elsewhere but much less attention was paid to an issue of wider importance: how EWI outperformed a similar pooled fund from the same management company, focused on the same investment sector, with the same individual fund manager. Nor is there anything unusual about how this investment trust delivered substantially more to shareholders over the last decade and one-year periods than its counterpart Baillie Gifford Global Discovery, not an investment trust but an ‘open-ended fund’.
New analysis of investor returns by the AIC using Morningstar data shows that 77% of investment trusts with open-ended counterparts beat them over the last decade. Nor was the investment trusts’ outperformance trivial. The average among these investment trusts paid shareholders £31 more per £100 invested than their open-ended rivals. That’s nearly a third better in share price total returns over the last decade.
“…77% of investment trusts with open-ended counterparts beat them over the last decade. Nor was the investment trusts’ outperformance trivial.”
In all, the AIC found 35 ‘sister fund’ pairs to compare investment trust and fund performance over ten years, and 50 pairs over the one-year period, so both sample sizes are significant. To focus on the example we began with, EWI delivered total returns of 155% over the last decade or more than three times as much as its open-ended sister Baillie Gifford Global Discovery, which returned 43%.
Similarly, EWI achieved a total return of 38% over the last year, compared to 9.7% from its open-ended sister. Both funds are managed by Douglas Brodie.
As mentioned earlier, there is nothing unusual about EWI beating its ‘ugly sister’ over long and short periods. Consider another investment trust where I am still a shareholder, BlackRock Latin American (BRLA) which delivered 136% over the last decade and 56% over one year. By contrast, its open-ended sister BGF Latin American, also managed by Sam Vecht, delivered 91% and 39% over the same two periods.
Closer to home, another self-descriptive investment trust, European Smaller Companies Trust (ESCT), delivered 230% over the decade and 15% over one year. By contrast, its sister Janus Henderson European Smaller Companies, also managed by Ollie Beckett, Rory Stokes and Julia Scheufler, delivered 210% and 19% over the same periods.
To be fair, the open-ended sister’s outperformance over that last short period demonstrates that investment trusts do not always do better. However, Morningstar data shows that 82% of investment trusts beat their sister funds over one year and the cash value of that outperformance was worth an average of £5 per £100 invested.
“…82% of investment trusts beat their sister funds over one year and the cash value of that outperformance was worth an average of £5 per £100 invested.”
So what’s going on? Why is it that similar-sounding pooled funds, which both help reduce the risks of stock market investment by diversification – or spreading investors’ money over dozens of different underlying companies, countries and currencies – produce such different outcomes?
At this point, some City jargon is unavoidable. Investment trusts are closed-ended funds. That means there is usually a fixed number of shares in an investment trust, whose price is determined by the level of demand on the stock market. By contrast, managers of open-ended funds match the supply of units to align with fluctuating demand from investors by creating or cancelling units, whose price is based on the net asset value.
While that distinction might sound technical, it means investment trust fund managers are never forced to sell underlying assets to align with investor demand. So, unlike their open-ended rivals, closed-ended funds can invest permanent capital for the long term, rather than being forced by short term slumps in stock market sentiment to dispose of assets at what can be unfavourable ‘fire sale’ prices".
“…closed-ended funds can invest permanent capital for the long term, rather than being forced by short term slumps in stock market sentiment to dispose of assets at what can be unfavourable ‘fire sale’ prices.”
That ability might be particularly valuable in sectors where prices are volatile, such as smaller companies, or when investing in assets which are not listed on any stock exchange. Open-ended funds – sometimes called OEICs or unit trusts – are largely excluded from holding unlisted assets. (This was an important factor in the outperformance of Baillie Gifford Global Discovery by Edinburgh Worldwide, which has a substantial holding in SpaceX.)
Other important differences include investment trusts’ ability to borrow to invest, unlike open-ended funds which are barred from what is sometimes called ‘gearing’. However, it is only fair to point out that gearing can help or hinder investor returns, depending on whether the performance of the assets being bought exceeds or falls short of the cost of borrowing.
“Other important differences include investment trusts’ ability to borrow to invest, unlike open-ended funds which are barred from what is sometimes called ‘gearing’.”
As a result of all or some of the above differences, investment trusts shares are often priced below their net asset value (NAV), when they are said to be trading at a ‘discount’, and are sometimes above NAV, when they are said to be priced at a ‘premium’. This introduces another layer of potential rewards – if discounts shrink during the period of investment – or risks – if they get bigger.
Either way, it is well worth investors considering carefully such apparently technical issues. As we have seen, these similar-sounding forms of pooled funds can produce very different outcomes for investors – and, setting aside PG Wodehouse’s national stereotypes, that’s no joke.
Ian Cowie is a shareholder in BlackRock Latin American (BRLA) and European Smaller Companies Trust (ESCT) and was until recently a shareholder in Edinburgh Worldwide Investment Trust (EWI) as part of a globally diversified portfolio of investment trusts and other shares.
