Various studies have suggested that fund managers who are prepared to back their best ideas à la Warren Buffett fair best, but this isn’t the case among UK Equity Income and UK growth closed-ended portfolios.
FE Trustnet looked at the 37 vehicles across the two sectors (the three mid-cap trusts were excluded) and took the nine with the highest proportion of their assets in the top-10, and the nine with the lowest proportion of their assets in the top-10. These 18 trusts were used as they represent the top and bottom quartile of the sector for conviction.
Our data shows that the average high conviction trust has returned 31.62 per cent over a three year period, compared to 51.42 per cent from the more diversified group. The highest conviction funds have also been significantly more volatile.
Performance of portfolios over 3yrs
Source: FE Analytics
The dominance of the more diversified funds also extends over the longer-term; they come out well on top over both five and 10 years, each time delivering outperformance with less volatility.
Source: FE Analytics
It’s worth pointing out that the high conviction trusts have beaten the FTSE All Share – the natural benchmark for a UK equity vehicle – over all three time periods, but in general investors would have been much better off backing a manager who spreads his assets across a greater number of companies.
Among the best performing trusts in the diversified portfolio include James Henderson’s Lowland Investment Company and The Mercantile Investment Trust, which are both up more than 250 per cent over the last decade.
The standout performer in the high-conviction portfolio is FE Alpha Manager Nick Train’s Finsbury Growth & Income trust, which has delivered 295.01 per cent over 10 years, and almost 200 per cent over five. However, the likes of Manchester & London IT and the Hansa Trust have been a big drag on performance in recent years.
Mark Dampier (pictured), head of research at Hargreaves Lansdown, says that running a high conviction portfolio is generally a positive attribute, but thinks some managers get carried away with their best ideas.
He points out that unlike open-ended funds, investment trusts can hold in excess of 10 per cent in a single company. “There’s certainly a case for holding onto your winners, but sometimes when a manager allows a stock to go to 10 per cent and beyond, it can get silly,” he said.
“If there is a change in sentiment you can get panned. Look at what happened to ASOS recently.”
High conviction trusts have particularly struggled on a relative basis in down markets. In 2011, for example, they lost more than 15 per cent of their value, compared to 6.34 per cent from their more diversified counterparts. They also fell harder in 2008.
Dampier says this is a particular issue for UK managers focusing on small caps, as these companies tend to be more volatile and have a higher risk of default.
Performance of portfolios over 10yrs
Source: FE Analytics
Among the trusts with a big bulk of their assets in a single company include Manchester & London IT, which has 23.8 per cent in PZ Cussons and 11.2 per cent in Glencore, as well as the Hansa Trust, which has a whopping 35.6 per cent in Brazilian-focused stock Ocean Wilson.
Ewan Lovett-Turner, investment trust analyst at Numis Securities, agrees that investing in a closed-ended portfolio with as much in a single stock can be risky. He points out that some major positions are legacy holdings, bringing into question how much conviction the manager actually has in them.
“The Hansa trust is an example of a trust with a lot in a single company,” he said. “It has some quite specific and esoteric strategies, including a major holding in Ocean Wilson.”
“The management has a lot of personal interest in the stock, but that said they appear to have a very firm view on it. When investing in a trust like this you have to be aware that it has a large portion of its assets in one stock, and so need to take a view on the company in its own right. If you want mainstream equity exposure, you should probably steer clear.”
Lovett-Turner says that these major single stock positions can present compelling value opportunities. Ocean Wilson’s high level of exposure to Brazil has contributed to a tough period for both the company and the Hansa Trust in recent years, reflected by the trust’s current 20 per cent discount.
“There are times when these kind of trusts are at very attractive entry points,” he said. “They certainly have a very different risk/return profile to more mainstream trusts, but I would expect there to be a role reversal in performance. They are very much long-term holdings.”
“The Hansa trust has made 220 per cent over the last decade.”
While he says holdings with more than 10 per cent exposure need attention, Lovett-Turner says trusts' flexibility gives them an advantage over their open-ended rivals.
“It depends how it is used, but flexibility is generally a good thing,” he said. “Similarly, investment trusts are able to hold a number of assets that funds can't hold.”
“The Personal Asset Trust has its gold exposure through physical bullion for example, which the manager [Sebastian Lyon] can't do when running Troy Trojan.”
