The lack of capacity in the investment trust sector means that closed-ended products will always remain a niche part of the market for specialist investors, according to head of research at Hargreaves Lansdown Mark Dampier. Dampier (pictured) says he likes the closed-ended structure for certain asset classes and welcomes the inclusion of them in investors’ portfolios; however, he says there’s no chance they will ever displace open-ended funds because there’s simply not enough liquidity to cater to increased demand.
“Everyone goes on about investment trusts being better funds, and yes there are some advantages. However, this idea that they can replace funds and be used instead of them on a wide scale in pensions and so on doesn’t make any sense,” he said.
“If you look at the IT UK Equity Income there’s something like £9.2bn in there. That’s smaller than some single open-ended funds.”
“There isn’t the capacity to cater for a mass move into the sector. It’s a closed-ended structure, so the only way that there can be a big improvement in capacity is if there are a load of launches, which I don’t see happening, or if they change their structure and become open-ended, which completely defeats the object.”
“I’m not for one second knocking investment trusts, but if you do the maths the figures just don’t add up. They will have to remain a niche part of the market, and I think that’s no bad thing.”
“If you want them to replace funds then there will have to be a shake-up in the structure, which will dilute the advantages they have in the first place.”
Dampier highlights Sebastian Lyon’s Personal Assets Trust as one that has taken on open-ended characteristics in order to appease demand. Lyon uses a discount control mechanism to ensure the trust doesn’t go onto a steep discount or premium.
“He issues shares when it goes on to a premium and that’s where a lot of the growth has come from in recent years,” he said, adding that the manager also chooses not to gear – another advantage proponents of closed-ended funds point to.
The largest fund in IMA UK Equity Income is currently Adrian Frost’s £6.9bn Artemis Income portfolio. Invesco Perpetual Income and High Income, which recently left the sector due to their failure to hit the 110 per cent yield target, are £6.5bn and £12.4bn in size respectively.
FE data shows that the IMA UK Equity Income sector currently has combined assets of just over £53bn – almost six times as much of the IT UK Equity Income sector. There are some income-focused UK trusts that do sit outside the sector, such as Mark Barnett’s Keystone IT, though the same point can also be made about open-ended funds, with the two Invesco income funds the obvious examples.
Source: FE Analytics
According to the AIC, the combined assets across the IT UK Equity Income and IT UK All Companies sectors are just shy of £14bn, spread across 41 vehicles. The figure for the equivalent sectors in the IMA UK Equity Income and IMA UK All Companies sectors is £200bn spread across 364 vehicles, FE data shows.
Other popular sectors that have a severe lack of capacity is IT Global Emerging Markets, which has only 11 constituents with total AUM of £5.2bn, and IT Europe, which has only nine constituents with total AUM of less than £2.5bn.
The Aberdeen Emerging Markets Equity fund alone has assets worth £7.7bn, while the £2.4bn Jupiter European fund is among the largest in the IMA Europe ex UK sector.
Charles Cade, head of investment trust research at Numis Securities, sympathises with Dampier’s view, though points out that self-interest does play a part.
“For the mass market, I think the open-ended structure will always dominate, unless closed-ended funds become more open-ended,” he said.
“There’s an obvious issue for the big platforms because of this issue of liquidity. If their customers want to put in tens of millions of pounds into an investment trust, they’re going to have a problem.”
“To some degree I do think [Dampier is right]. The liquidity constraints mean there can’t be billions coming in. This would create a problem for the structure. Having said that, there have seen some big issuances from trusts like Finsbury Growth & Income and City of London in recent years, which has freed up some capacity.”
“But no, from a mass distribution point of view they aren’t going to compete.”
Cade says the biggest areas of growth in the closed-ended market have come from specialist products best-suited to the closed-ended structure and believes this trend will continue.
“If you look at where the growth has been, it’s been in the trusts that benefit from the structure – the yield enhancement, the longer-term view, the liquidity advantages and so on,” he said.
“When looking at the plain vanilla trusts, I don’t think you are going to see more growth, which is why there have been so few global trust launches.”
Dampier adds that the cost advantage that trusts once had over funds, which he believes was fictitious in the first place, has dissipated. This is also likely to put the brakes on any significant move from investors into the sector, he says.
“When you see most journalists talking about the advantages of trusts they tend to talk about performance, but there are other things to consider,” he said.
“Most investment trusts are now more expensive than funds. Most of them were never cheaper in the first place, which the rise of clean share classes has shown.”
FE Trustnet highlighted the diminishing cost advantage of trusts over funds in an article earlier this year.
The higher trading costs of investment trusts – some platforms charge up to £12 for every transaction and 0.5 per cent stamp duty on all purchases – contributes to the question markets over the cost effectiveness of the structure, particularly for low-end investors.
Using the costs above, a £1,000 investment into a trust would bump up the ongoing charges figure by well over 1 per cent – even before the bid-offer spread is taken into account.
Cade agrees that these costs mean lower-end investors shouldn’t actively trade investment trusts, but that’s not to say they should ignore them altogether.
“It becomes uneconomic to invest with very small amounts,” he said. “You’re better off using a significant ISA allocation and not being too active.”
“If you can get into a trust when its cheap then I see no problem, but if you’re an active investor, you need to be trading in bigger amounts.”