Investors can no longer assume investment trusts are automatically cheaper than their open-ended fund rivals, so how do investors know which to choose?
New research by analysts Canaccord Genuity has confirmed that investment trusts have lost their traditional cost advantage since the abolition of adviser commission three years ago. Commission was previously included in the annual management charge of open-ended funds and its removal has made them appear cheaper.
Canaccord studied the charges of 51 investment trusts with directly comparable open-ended funds, investing in the same market and more often than not run by the same manager. It found less than half – 45% – were the cheaper option.
A total of 23 investment trusts had a lower annual on-going charge while 27 investment companies were more expensive and one was the same. The differences were often small though: two thirds of the trusts with a higher charge levied less than 0.25% more than the open-ended counterpart.
However, even small differences in charges can add up and erode investor returns over time.
Alan Brierley, analyst at Canaccord, said the findings were a 'wake-up' call for investment trust boards to keep their charges competitive. In a low growth, low return fund charges ‘have a much greater dilutive impact on returns, particularly when compounded over the long-term’ and should be reduced as far as possible, he said.
Fortunately, investment trusts still retain a performance edge over open-ended funds. Mainly because of their ability to gear, or borrow, and invest more money on behalf of shareholders, Brierley found that 'a large majority of investment companies have outperformed comparable open-ended funds and benchmarks during the five years to 30 September 2016’.
‘This contrasts starkly with the poor performance of the wider active management community in recent years,’ he added.
A spokeswoman for the Association of Investment Companies, the industry's trade body, said managers of trusts were able ‘to take a long-term view of their portfolio, without being forced to sell assets in volatile markets’ and the ability to gear the trusts ‘have all contributed to the strong performance record’.
She added that since the abolition of commission ‘charges for open-ended funds have decreased’ and the response from investment companies was to follow suit.
‘Over a third of investment company boards have responded to this by reducing their charges for the benefit of investors,’ she said. ‘This is a win-win for consumers. Many of the retail focused investment companies have very competitive charges and investors need to do their research when choosing an investment.’
Sweet 16, nifty 9
All this means is that it is possible to identify investment trusts with good performance and lower charges.
In the report Brierley and colleague Ben Newell identified 16 investment trusts that were not only cheaper than their open-ended counterparts but whose five-year returns had beaten the benchmark stock market indices used to measure their performance.
In the table below we've also highlighted nine really nifty trusts that have beaten their equivalent open-ended fund as well.
These include two trusts, Edinburgh (EDIN) and Perpetual Income and Growth (PLI), run by Citywire A-rated Mark Barnett, which are cheaper and have a better performance track record than the big flagship Invesco Perpetual High Income fund he also manages.
Source: Canaccord Genuity. Performance based on five years to 30/9/16.
# trusts' total shareholder returns over five years also beat their equivalent open-ended funds: Impax by 5.1%, Monks by 4%, Henderson Smaller Companies by 3.5%, Invesco Perpetual UK Smaller Companies by 3.4%, Fidelity European Values by 2.8%, Edinburgh 1.9%, Aberforth Smaller Companies by 1.4%, Perpetual Income and Growth by 0.7% and Invesco Income Growth by 0.3%.
Top of the list is Henderson Smaller Companies (HSL) which demonstrates the cost and performance advantages an investment trust can bring. Its manager Neil Hermon boasts also a Citywire A-rating for the track record of the sister Henderson UK Smaller Companies fund he runs. Over five years to the end of September that fund delivered an annualised return of 19.6% beating the 15.7% from the Numis Smaller Companies index, according to Morningstar data used by Canaccord.
That's good but Henderson Smaller Companies did even better: under Hermon the net asset value of the portfolio has grown by 21.1% a year in the past five years. Shareholders actually received an average annual total return of 23.1%.
Meanwhile the trust charged shareholders 0.44% of net assets in its last financial year compared to the 0.84% levied by the UK Smaller Companies fund. A better return and lower charge makes this a good value investments.
There is one wrinkle, however. Hermon and his employer Henderson Global Investors can earn a performance fee if the trust's NAV beats the Numis index and the share price rises during the financial year. That will increase the charge investors pay although total charges including the performance fee are capped at 0.9%.
So in that scenario, the trust is more expensive than its sister fund but may also be making more money for investors.
You can use the fact sheet links in the table to find out more about the other investment trusts, comparable funds and their managers.