Strong outperformance by investment trusts

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Strong outperformance by investment trusts
Master Investor Magazine

Master Investor Magazine 58

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Over the last ten years the majority of investment trusts have outperformed their equivalent open-ended funds and in a handful of cases the difference was more than 100%.

Research conducted by platform provider AJ Bell has compared the performance of funds and investment trusts that are run by the same manager and which invest in similar assets. They found that the trusts generated stronger returns than their equivalent open-ended funds three-quarters of the time, over both the last year and decade.

The difference in performance between a fund and trust run by the same manager varies dramatically and in some instances it is enormous. In the 10 most extreme examples the trust outperformed by between 64% and 259% over 10 years!

Massive return differentials

Heading the list is Neil Hermon’s Henderson Smaller Companies Trust (LON:HSL) and Janus Henderson UK Smaller Companies fund with respective gains of 620.9% and 362%. If you chart the performance you can see that they are highly correlated, as you would expect, yet the investment trust is clearly the more volatile of the two.

The next most extreme difference is between the Baillie Gifford Shin Nippon (LON:BGS) investment trust and Baillie Gifford Japan Smaller Companies fund, both of which have been run by Praveen Kumar since 2015. They both invest in smaller Japanese companies and currently share nine of their top ten holdings, yet over the last decade they have returned 678.4% and 422% respectively.

Another example is Andrew Brough’s Schroder UK Mid 250 fund and Schroder UK Mid Cap Trust (LON:SCP)that both invest at least 80% of their assets in UK mid-cap stocks. They each have around 60 holdings with a handful of their top ten positions overlapping, but the trust has delivered more than double the performance with a ten-year gain of 373.7% versus the 185% generated by the fund.

When making these comparisons it is important to bear in mind that the last ten years was a lucrative period for investors with asset prices recovering strongly after the financial crisis. Factor in the historically low interest rates and it becomes obvious that a lot of the difference must be down to the gearing.

Why the huge difference?

Investment trusts can use gearing or borrowing to boost their returns. In effect, this works as an accelerator on performance, so that when the trust’s NAV is rising it experiences larger increases than a vehicle that doesn’t use gearing. The converse is also true, with larger potential losses in falling markets.

If you look at a chart of a comparable trust and fund you can see the sharper rises and falls in value, hence the reason that in 90% of cases the trust is more volatile than the equivalent fund.

Another contributory factor to the difference in performance is that in 31% of the cases the trust is cheaper, which would imply that the returns should be bigger. In only 15% of the comparisons was the fund the better value option.

The gearing and the fact that average investment trust discounts have narrowed could leave them vulnerable in the event of a market sell-off, although a lot depends on the foresight of the manager. If they see the problems coming they should be able to de-gear their portfolios and switch into more defensive holdings.

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