Trusts and their mirror funds: who is the fairest?

Many investment trusts have an open-ended equivalent and, from time to time, we are asked whether there is an inherent advantage to the former when it comes to performance.

Arguably, a comparison of the two structures by a research team focused on investment trusts carries some risk of confirmation bias, but with our most ardent promise of a fair hearing, in this study we give it a go - analysing the performance of funds and trusts with global exposure during the most recent, tech-driven rally, further back too…

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Weighing in the contestants

In the interest of fairness, let’s start by acknowledging some merits of the OEIC structure. We think it’s safe to say that the open-ended structure is generally simpler to understand, as there is no premium/discount mechanism and no gearing involved, and the lack of gearing means there can be less downside risk. Investment trusts aren’t always the most liquid equities, so spreads can widen in down markets too, whereas with open-ended funds you only need to worry about the spread on the equities in the portfolio.

Having fulfilled our duty of courtesy, let’s turn to the advantages of investment trusts. First, the permanency of capital means managers do not have to worry about inflows and outflows, which helps preserve their strategy, avoid cash drag and pursue opportunities in less liquid assets. While gearing and the premium/discount mechanism add complexity, they can also enhance performance. Thanks to these unique features, investment trusts are theoretically better positioned to outperform open-ended funds in rising markets – and therefore, over the long term.

Round one

However, we know that theory and practice don’t always align. As a result, we examined performance data to see whether the theory holds up. For our analysis, we chose the AIC Global, Global Equity Income, North America, and Technology & Technology Innovation sectors, along with their open-ended equivalents. We appreciate that the AIC universe is broader than this, and we may look at other sectors in the future, but we selected these specific sectors this time around because they were recently (or had the potential to be) exposed to a rising market, spurred by the AI rally. We chose the launch of Chat GPT (30/11/2022) as a starting point for measuring performance. We also reviewed performance over five years (to 01/11/2024) to assess longer-term returns. We defined an open-ended sibling as any fund that has shared at least one manager with its investment trust counterpart for a minimum of five years, broadly follows the same investment goals, and falls within an equivalent Investment Association sector. The table below lists the investment trusts for which we could identify open-ended counterparts, indicating whether their cumulative fair NAV performance has outmatched the total returns (TR) generated by their open-ended sibling since ChatGPT’s launch and over the five-year period ending 01/11/2024.

PERFORMANCE FROM 30/11/2022 TO 01/11/2024 AND OVER FIVE YEARS (to 01/11/2024)

Source: Morningstar, AIC, Kepler estimations. Past performance is not a reliable indicator of future results

Based on our sample of seven pairs, investment trusts seem to produce better returns than open-ended funds over the long term and in rising markets, with 57% of investment trusts having outperformed their open-ended version over the AI rally and 71% over five years.

Round two

However, we did not include share price TR performance in our table, as it is a function of demand and supply for shares of an investment trust and does not reflect NAV performance. Share price TR performance is what investors ultimately receive, but can diverge from NAV performance significantly at times. In each period measured, only 29% of the trusts in our list have delivered both cumulative fair NAV and share price TR in excess of their open-ended version’s total returns.

This weak share price performance reflects the fact that discounts have widened, particularly since 2022. Higher interest rates have made fixed-income instruments or simply holding cash more attractive than risk assets, which likely impacted demand for investment trusts’ shares. Concerns about a potential global recession have also likely played a role, as investors are often tempted to seek refuge in safe-haven assets such as sovereign bonds and gold in those circumstances, as we discuss here. Furthermore, investment trusts have faced regulatory challenges around cost disclosures, which we address here. We note that even those trusts that have performed very well over the past year still trade on wide discounts at the moment. In our view, this reflects opportunity: discounts should close to NAV over time, even if it takes corporate activity.

The champions

Notwithstanding the general picture of widening discounts, two trusts stand out as having outperformed their open-ended peers in both share price and NAV terms: JPMorgan Global Growth & Income Ord (LSE:JGGI)and Martin Currie Global Portfolio Ord (LSE:MNP). The chart below illustrates the cumulative fair NAV and share price performance of these two trusts, alongside the total returns generated by their open-ended equivalents over five years.

FIVE-YEAR PERFORMANCE

Source: Morningstar. Past performance is not a reliable indicator of future results

JGGI shares a global equity income mandate, an additional goal of providing capital growth and a manager, Helge Skibeli, with JPM Global Equity Income. The trust has been a successful consolidator, absorbing three other investment trusts since the start of calendar year 2022: Scottish Investment Trust (SCIN), JPMorgan Elect (JPE) and JPMorgan Multi-Asset Trust (MATE). As a result, JGGI has gained scale, increasing its assets under management (AUM) to £2.8 billion (as of 30/09/2024), making it more attractive to a larger pool of investors. This increased size, along with good performance and the growth and income offering, have helped push the trust to a 1.2% premium at the time of writing, meaning the trust is able to issue new shares into the market and grow even further. This can only lower the ongoing charges figure (OCF), which is already significantly lower than the open-ended equivalent, at 0.48% versus 0.90% for JPM Global Equity Income.

JGGI funds its dividend from both capital and income, a feature not available to open-ended funds, but giving investment trusts more versatility. This means the trust is able to invest in growth-oriented sectors and stocks, which are traditionally not associated with income strategies. As of 05/11/2024, Morningstar data shows JGGI with 35.5% of its portfolio invested in growth stocks, compared to 17.9% for JPM Global Equity Income. Morningstar classifies stocks as growth or value using a combination of forward- and backward-looking measures, including historical earnings and sales growth for growth stocks, and price-to-book and price-to-sales ratios for value stocks. JGGI also offers a higher yield than its open-ended counterpart. At the time of writing, the trust has a historic yield of 4.1%, while JPM Global Equity Income’s latest factsheet (dated 30/09/2024) reports a yield of c. 2.2%.

JGGI’s gearing has also contributed to good performance in a rising market. While JGGI has used gearing moderately, as indicated by an average net gearing of approximately 1.8% over the five years to 31/10/2024, it has been employed tactically, based on key macroeconomic indicators and valuation expectations, as shown in the chart below.

NET GEARING

Source: Morningstar.

MNP has achieved a similar feat, with its NAV and share price total returns outperforming FTF Martin Currie Global Unconstrained Fund over five years and over the AI rally. Both strategies, managed by Zehrid Osmani, follow a high-conviction approach, each holding only 31 stocks (as of 30/09/2024) that the manager believes can benefit from megatrends shaping the global economy, such as AI, energy transition and an ageing population.

The board of MNP operates a zero-discount policy, meaning that it aims to keep the trust’s shares to trade as close to NAV as possible, and this is achieved through share repurchases. This policy seems to have borne fruit, as the chart below shows, with MNP having traded at an average discount of 0.8% over five years (to 07/11/2024). As a result, MNP’s share price TR performance has closely tracked the trust’s cumulative fair NAV performance.

FIVE-YEAR DISCOUNT

Source: Morningstar

Therefore, we think it makes sense to look at what has driven MNP’s cumulative fair NAV outperformance relative to the total return generated by FTF Martin Currie Global Unconstrained Fund. In our view, gearing may have played a significant role, with an average gearing of 6.2% over the five years to 31/10/2024. Zehrid believes that structural gearing can enhance long-term returns for shareholders, although it may also increase potential losses in down markets, as seen in 2022.

We also think that the stability of capital provided by the investment trust structure may have enabled Zehrid’s strategy to come into its own, delivering better results than the open-ended version. Finally, we note that MNP has a lower OCF than FTF Martin Currie Global Unconstrained Fund, at 0.64% versus 0.86%.

The judges’ scores

We think we have shown that the strong performance of global-focused trusts over the AI rally has been helped by the unique features of the structure, such as permanency of capital, gearing or the flexibility investment trusts have to pay dividends.

However, strong NAV performance has not always been accompanied by strong share price performance. We think, though, that looking forward, this implies opportunity. An investment trust trading at a discount offers an additional source of potential alpha to any open-ended fund, although of course it may take some time for a discount to close.

A worked example makes it clear how these advantages can compound. Let’s imagine an investment trust is trading today on a 10% discount, has a 5% gearing and goes on to return 7% per annum over the following five years. Without gearing, the NAV return (and the return on an open-ended fund with an identical portfolio and fees) would be c. 40%, which would rise to c. 42% with gearing. Then, if we assume that the trust’s discount completely closes over this period, we get a share price return of c. 57% (this is what goes into your pocket).

Ultimately, both investment trusts and open-ended funds have their pros and cons, and it’s up to investors to decide what structure they feel more comfortable with. Investment trusts do have extra risks to be aware of, but we think they are outweighed by the advantages for long-term investors.