<p>Read a little about investment funds and you&#8217;ll soon come across someone saying &#8220;investment trusts outperform other types of fund&#8221;. There are good reasons to believe that they may do, but it&#8217;s a very difficult thing to prove.</p>
<p><!--more-->You don&#8217;t tend to get people claiming the opposite, unlike the passive versus active debate that rages across the financial Internet. But as this site is dedicated to investment trusts, it would be remiss if I didn&#8217;t add my 2p on this matter!</p>
<h2>When a little becomes a lot</h2>
<p>My own feeling is that investment trusts do indeed outperform, most of the time and only by a small amount. But even a small outperformance a year can make a difference to lifelong investors.</p>
<p>Say you manage to generate returns of 8% a year for 40 years. Congratulations! You&#8217;ll end up with 22 times your initial stake.</p>
<p>Do a little better, 8.5% for example, and you&#8217;re up to 26 times. In other words, you end up with 20% more as a final sum.</p>
<p>Should you manage 9.0%, it&#8217;s 31 times and 45% more. Spectacular job!</p>
<p>If only the real world were so simple. In practice, you&#8217;ll probably invest a little each year, and the returns will see-saw all over the place. The end result should be the same, though. It&#8217;s why many people think that shaving even a little off investing costs is well worth the effort.</p>
<h2>Why might investment trusts outperform?</h2>
<p>As well as data backing up a theory, I also tend to look for sensible reasons why any premise like this might be correct. Here are a few:</p>
<ul id="space">
<li><strong>Investment trusts can borrow money</strong><br />
And many of them do. Markets tend to rise more than they fall (and they rise slowly and fall quickly). This means borrowing should be a net positive for returns. Of course, you have to make sure too much borrowing doesn&#8217;t wipe you out at any point.</li>
<li><strong>Investment trusts have a fixed pool of capital</strong><br />
Most other funds have to buy and sell their underlying assets when people put more money into a fund or take some out. So such funds can be forced buyers and sellers when they&#8217;d rather not be.</li>
<li><strong>Investment trusts have a long-term mindset</strong><br />
An investment trust&#8217;s board should ensure the investment manager is up to scratch and they can hire and fire if needed. Despite this, many investment trust managers have run the same fund for a very long time. The AIC reckons half of funds have had the same manager <a href="https://www.theaic.co.uk/aic/news/press-releases/longest-serving-managers">for 10 years or more</a>, and four managers have run the same fund for over 30 years.</li>
<li><strong>Investment trusts can&#8217;t market themselves</strong><br />
The mainstream fund business is about <a href="http://www.itinvestor.co.uk/2018/07/key-numbers-for-the-investment-trust-industry/">seven times the size</a> of the investment trust sector. Part of the reason for this is that they can advertise themselves (which we end up paying for as investors of course).</li>
<li><strong>Investment trusts are cheaper</strong><br />
As a consequence of the last two points, the costs you pay within the fund should be lower for investment trusts. That has been the case in the past, but it seems to be less true these days with more investment trusts moving into specialist areas and charging higher fees as a result. However, on many platforms, it&#8217;s often cheaper to hold investment trusts, as administration charges tend to be capped.</li>
</ul>
<h2>Assessing the evidence</h2>
<p>There have been quite a few studies looking at whether investment trusts outperform, and I look at some later in this piece.</p>
<p>Some look at all investment trusts, and this can be problematic as many of them invest in different types of assets. The recent popularity of infrastructure and debt finance investment trusts is a case in point.</p>
<p>Other research compares sectors with similar remits, like Global or UK All Companies. A few drill down even further and compare instances where the same fund manager runs a mainstream fund and an investment trust equivalent.</p>
<p>Even this last approach has complications. The portfolios could still differ if the funds were started at different times, so it&#8217;s hard to strip out whether any performance difference is down one fund being an investment trust.</p>
<p>Like all performance studies, the problem of survivor bias is ever-present. In other words, how do you make sure you include <em>every fund</em> that was available at the start of the period you are examining. When you are looking at long periods, you&#8217;d find that many funds will have closed down. Some will have merged with others or perhaps changed the way they invest.</p>
<p>And do you take a straight average of the performance of all funds? Or do you weight it according to the size of the funds? Once you get in the nitty-gritty, what seems like a simple question becomes insanely complex and highly subjective.</p>
<h2>Exhibit #1: Cass Business School</h2>
<p>This report was only <a href="https://www.cass.city.ac.uk/news/2018/june/investment-trust-managers-have-outperformed-managers-of-unit-trusts">published last month</a> but generated a fair amount of coverage as it came from the academic world rather than a financial services company.</p>
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<p>I haven&#8217;t seen a copy but it seems to cover 2000-2016. It suggests investment trusts outperformed by 0.8% a year once you adjust for factors like asset allocation and borrowing levels.</p>
<p>It seems to focus on net assets rather than share prices, which circumvents the issue that investment trust discounts have been <a href="http://www.itinvestor.co.uk/2018/07/key-numbers-for-the-investment-trust-industry/#chart">narrowing for some time</a>. Like lower costs, this is another factor that may not persist in future. The authors are hoping to expand the period covered to 1994-2018.</p>
<h2>Exhibit #2: Numis</h2>
<p>Numis Securities did a study of <a href="http://citywire.co.uk/investment-trust-insider/news/how-investment-trusts-beat-other-types-of-funds/a794187">17 sectors over 10 years</a> a few years back. It found investment trusts did better in 15 out of those 17 sectors.</p>
<p>Who were the slackers? Well, Japanese Smaller Companies (an oddly specific sub-sector I&#8217;ve always thought) and Property let the side down.</p>
<h2>Exhibit #3: Winterflood</h2>
<p>More recently, Winterflood Securities <a href="http://citywire.co.uk/investment-trust-insider/news/proof-that-investment-trusts-beat-funds-80-of-the-time/a1076126">compared 45 funds</a> over the last 5 years where an investment trust and open-ended fund was run by the same manager. It found that the investment trust won the day 35 out of 45 times.</p>
<p>There was a big range here, though, with one investment trust outperforming by 67% over 5 years. Another underperformed by 13% over the same period. So I don&#8217;t think we can be truly comparing like with like in many cases here. And 5 years is probably too short a period to draw any real conclusions.</p>
<p>An earlier study by Winterflood looked at <a href="https://www.investorschronicle.co.uk/2011/09/15/your-money/why-investment-trusts-beat-open-ended-funds-A29Q0pByJ7lfpYuOtjw4XP/article.html">sectors over 10 years</a>. It found investment trusts outperformed 7 out of 8 times with Japan, once again, being the exception. Something in the saki perhaps.</p>
<h2>Exhibit #4: The AIC</h2>
<p>This study goes back an impressive 30 years. It reckons the average investment trusts produced returns of 1,955%, versus 1,196% for the FTSE All-Share, and 919% for open-ended funds.</p>
<p>That&#8217;s a big difference, so I suspect this doesn&#8217;t adjust for survivorship bias and only looks at funds that still exist today. You would expect poorly performing investment trusts to have a shorter life expectancy than mainstream funds.</p>
<h2>Summary</h2>
<p>I very much doubt that we&#8217;re ever going to get a definitive answer to the question of do investment trusts outperform. And I&#8217;m ok with that. Investing isn&#8217;t black and white, it&#8217;s about the balance of probabilities.</p>
<p>Common sense suggests investment trusts should have a small advantage, and what research has been done hasn&#8217;t thrown up any glaring evidence to the contrary.</p>
<p>And it does seem like fund managers themselves prefer investment trusts. In a recent Investors Chronicle podcast Peter Hewitt, who runs a couple of funds for F&;C that invest in other funds, says he often asks &#8220;which one do you invest in?&#8221; when talking to managers who run similar open-ended funds and investment trusts. Apparently, they nearly always answer &#8220;the investment trust&#8221;.</p>
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Do you have a copy of the CASS study mentioned above?
I ask as I cannot lay my hands on a copy of the report.
However, I understand that publication was delayed until Q4 2018 to allow time to ensure the results reported at a conference mid 2018 (re the period 2000-2016) were not skewed by "survivorship bias", and then publication was further delayed until 2019.
I don't have a copy I'm afraid -- I was just working on the original press release and the various articles that followed the initial presentation at http://www.mip-fit.com/
I hadn't heard that the publication had been delayed but it's not uncommon for research like this to remain private unfortunately.
Thanks for the speedy reply.
I gleaned the info about the delay from the Editors Notes to the 2019 edition of The Investments Trusts Handbook.
I guess time will tell if the work is ever published, but I, for one, am not holding my breath!