Liquidity, or the lack of it, is sometimes cited by financial intermediaries as a reason not to recommend closed-end funds like investment trusts because, they argue, a fixed supply of shares on the market may not be able to cope with rising demand without distorting prices.
On the other hand, they point out that open-ended funds, such as unit trusts or exchange-traded funds (ETFs), can always create new units to meet a spike in demand created by a financial fad or marketing push.
So much for the upside of units but the downside can prove very disadvantageous when the problem is not buyers but sellers. Next week will mark the 30th anniversary of the 1987 stock market crash and should prompt investors today to reconsider which form of pooled fund can best cope with such shocking setbacks and even thrive in the aftermath.
Talking to experts about Black Monday, 19 October, 1987, reminds me of why it is wrong to focus on liquidity – the ability to buy or sell stock when you want – as a disadvantage of investment trusts for advisers and wealth managers when it is an advantage for investors. Investment trusts can always be traded on the London Stock Exchange – although you might not like the price. By contrast, nothing on earth can force a unit trust manager to pick up the phone and make a market in their own units if they don’t want to.
Regulations are all very well but in moments of crisis markets can be affected by human emotion and other irrational factors. If that sounds theoretical, then consider stock market historian John Newlands’ recollections of Black Monday. He told me: ‘The thinking of anyone based in the south of England was in danger of being warped by effects of the Great Storm in October, 1987.
‘City of London workers arose to a backdrop of fallen trees on crushed cars, blocked commuter routes and even, in the pre-mobile era, of cut telephone lines. This combination created a sense of fear that a market collapse was in progress.
‘Today, my message is twofold. First, panicking does no one any good. Second, never buy a unit trust or an open-ended investment company (Oeic). In the 1987 crash, many unit trust houses took their phones off the hook because they could not cope with the wave of redemptions. At least investment trust investors who did want to get out, could do so, albeit at a depressed market price.’
Nor is John the only one who recalls this often-overlooked aspect of Black Monday. Richard Plaskett, investment trust director at JPMorgan Asset Management, pointed out: ‘At times of market stress, the closed-ended nature of investment trusts comes into their own. Trusts do not have to meet the cash outflows from redeeming investors and so are not forced to sell assets into illiquid, stressed markets.
‘Indeed, in the period immediately following the Black Monday crash, some trusts were able to use free cash and leverage to acquire stocks at prices that looked very attractive as markets rebounded.’
Top 20 trusts since 1987
|Investment trust / company||AIC sector||£|
|Rights & Issues (RII)||UK Smaller Companies||12,604|
|ICG Enterprise (ICG)||Private Equity||3,562|
|Scottish Mortgage (SMT)||Global||2,570|
|Finsbury Growth & Income (FGT)||UK Equity Income||2,440|
|European Assets (EAT)||European Smaller Companies||2,428|
|Pantheon International (PIN)||Private Equity||2,420|
|Law Debenture Corporation (LWDB)||Global||2,391|
|F&C Global Smaller Companies (FCS)||Global||2,224|
|Henderson European Focus (HEFT)||Europe||2,122|
|Mercantile (MRC)||UK All Companies||2,115|
|BlackRock Smaller Companies (BRSC)||UK Smaller Companies||2,061|
|Capital Gearing (CGT)||Flexible Investment||2,028|
|North Atlantic Smaller Companies (NAS)||North American Smaller Companies||1,992|
|British Empire (BTEM)||Global||1,925|
|Murray International (MYI)||Global Equity Income||1,825|
|JPMorgan MidCap (JPM)||UK All Companies||1,720|
|Temple Bar (TMPL)||UK Equity Income||1,664|
|JPMorgan American (JAM)||North America||1,623|
|Average investment trust||1,383|
|Average unit trust, open-ended investment company||796|
Source: AIC using Morningstar data showing £100 investment from 30/9/1987 to 30/9/2017, excluding 3i
This helped closed-end funds trounce their open-ended rivals over the 30 years since Black Monday. According to Morningstar, £100 invested in the average unit trust immediately before the 1987 crash would be worth £796 today. Not bad when you consider only £258 was needed to match inflation, according to the Bank of England. But pretty poor compared to the total return of £1,383 delivered on the same sum by the average investment trust; or 74% more than the average unit trust.
You can see the top 20 investment trusts over the last three decades in the table. Annabel Brodie-Smith, a director of the Association of Investment Companies, told me: ‘It’s striking that a wide range of investment company sectors feature in the list of best long-term performers, which demonstrates the versatility of the structure across different investment areas.’
Of course, lower costs and gearing (the ability to borrow and invest more money) also played their part in outperformance but it is wrong to overlook the importance of liquidity. Like insurance for homeowners, liquidity for investors can seem like a tedious detail – until there is a crisis and the ability to get back into cash becomes the only thing that matters.