In the days of commissions pre-RDR, open-ended funds were on average significantly more expensive than their closed-ended counterparts, with the average equity-focused vehicle charging an OCF of between 1.5 and 1.7 per cent.
The introduction of clean share classes has seen this figure come down considerably however; the vast majority in the IMA UK Equity Income sector costing investors less than 1 per cent, and are subject to the same platform charges as trusts. These days, the latter look comparatively expensive.
Using data from the AIC, the average trust in the IT UK Equity Income sector currently has an OCF of 1.13 per cent, rising to 1.30 per cent when performance fees are taken into account. When you compare this to a fixed 0.75 per cent for CF Woodford Equity Income, you can see why trusts are coming under increasing pressure.
The trend is true across a number of IMA and IT sectors. The average OCF including performance fees in the IT Global Emerging Markets sector is as high as 1.47 per cent.
It’s not just the annual charge that is giving cost conscious investors a headache.
In most cases when trading on platforms, investors have to cough up a broker fee of up to £12 every time they want to invest, pushing up the total cost of ownership – especially for investors who invest in relatively small quantities.
Throw on top of that stamp duty, currently at 0.5 per cent for all UK-listed investment trusts, and open-ended funds look increasingly attractive from a charges perspective.
Charles Cade (pictured), an investment trust analyst at Numis Securities, accepts that closed-ended funds have lost their edge when it comes to costs.
“When you factor in potential trading costs, the trading [bid-to-offer] spread for some of the smaller trusts, and stamp duty for those that are onshore, the argument that trusts are the low-cost route isn’t necessarily correct,” he said.
Investors don’t seem to have cottoned on to this trend however.
According to the latest FE Trustnet poll, 71 per cent of almost 1,000 FE Trustnet readers believe that investment trusts are cheaper than open-ended funds.“I think there’s an assumption that investment trusts are cheaper as historically commission was included in the fund fee,” said Rob Gleeson, head of FE Research.
“Charges were all bundled together making it confusing for investors, but now it’s very straight forward – you pay a platform fee, and a fund fee. Sometimes you have to pay a transaction fee, but an increasing number of platforms don’t charge for them anymore.”
“It’s now investment trusts that are the more complicated. You have to pay 0.5 per cent stamp duty, and up to £12 every time you want to buy or sell, which can make things very expensive if you are working in small quantities. Then you have the performance fee, which can be painfully complicated at times.”
“There are still advantages of investment trusts such as gearing, and they have the ability to hold back income, making it easier for them to grow their dividend every year. Their closed-ended style also suits certain types of illiquid investments, such as physical property.”
“However, the cost advantage they’d had historically has disappeared. Now the opposite is mostly true.”
Cade says that some trusts have brought down their charges in recent months and removed their performance fees.
He highlights Mark Barnett's Perpetual Income & Growth IT as one that is in desperate need of becoming more competitive.
It has an OCF of 0.93 per cent according to the AIC, which rises to 1.85 per cent when taking into account performance fees.
“There are a lot of investment trusts that were launched relatively recently with charges of between 1 and 2 per cent,” he said.
“Historically they were competitive to the standard 1.5 per cent for funds.”
“However, these days they look a lot more expensive. A lot have cut their fees and I think a lot will have to cut them further.”
“It’s less of an issue for the older global and UK trusts which are still very competitive, but in other areas you will have to see them come down.”
“Perpetual Income & Growth IT does standout. The board has stated that it is aware of this issue, which is encouraging.”
Temple Bar IT, City of London IT and Merchants IT all have an OCF less than 0.5 per cent.
FE Trustnet highlighted some of the other giant trusts that remain cheap relative to funds in a recent article.
Cade says the only way investment trusts can justify being more expensive than their open-ended rivals is through strong performance, and differentiated mandates.
He says the second of these is very evident, as specialist sectors such as private equity and physical commercial property don’t lend themselves to the open-ended structure.
“In more specialist areas, where the closed-ended structure is suited, trusts can justify charging more,” he said.
Stronger performance has also been evident is recent years, with closed-ended trusts beating their equivalents in the open-ended industry across the board.
FE data shows that the average UK Equity Income trust has significantly outperformed the average UK Equity Income fund over five years, for example.
Performance of IMA sector and IT sector over 5yrs
Source: FE Analytics
The outperformance has been aided by gearing and narrowing discounts in particularly.
However, with discounts now at historic lows, there are concerns over valuations and a possible correction in areas that have performed particularly strongly.
Troy’s Sebastian Lyon – himself an investment trust manager – recently said that record low discounts were a dangerous indicator of an increasingly overvalued equity market, while star manager James Henderson told FE Trustnet that he would buy his Henderson UK Equity Income & Growth fund over his Lowland trust, because the latter was trading at a premium.
Cade admits there is certainly less value in investment trusts than there has been, but says that there will be times in the future when closed-ended funds are again much more attractive from a valuation perspective compared to funds.
He says that the introduction of discount controls mechanisms, which help prevent trusts from going onto steep premiums and discounts, means that the chances of a steep correction from their current levels are much smaller.
“Trusts have been very effective at buying back shares at discounts and issuing them at a premium, which has provided a big uplift to performance,” Cade said.
He adds that certain areas – namely UK small caps, which have recently seen their discounts come widen significantly in recent weeks – still offer considerable value.
FE Trustnet will look at some of Cade’s favourites in an upcoming article.
In the coming weeks, FE Trustnet will highlight open-ended alternative to expensive trusts in an upcoming series of articles, starting with UK Equity Income later today.
