In most cases the answer is yes: the best-performing investments over the long term – meaning a minimum 10 years – tend to be those with a high annualised volatility. As is often the case, however, there are always exceptions – especially when looking at closed-ended funds.
On a sector basis, open-ended funds certainly followed the expected trend, with the likes of IA China/Greater China and European Smaller Companies dominating over the past decade. Lower risk sectors such as IA UK Gilts and Targeted Absolute Return couldn’t keep up with the pace.
It’s more of a mixed bag when looking at investment trusts. Excluding unfocused sectors such as IT Specialist and those with less than three constituents with decade-long track record, the scatter graph below courtesy of FE Analytics shows returns (y-axis) versus annualised volatility (x-axis) over the 10 years to 1 January 2015.
Returns vs volatility for IT sectors over 10yrs
Source: FE Analytics
Among the best performers are indeed the most volatile, including IT Country Specialists Asia Pacific, European Smaller Companies and Asia Pacific ex Japan, which have all returned around 200 per cent. However some of the most volatile sectors such as Japanese Smaller Companies, Property Direct UK and Private Equity have struggled – at least on a relative basis.
The reason? Investment trusts are more volatile than their open-ended counterparts as both gearing and movements in the discount lead to more exaggerated swings in both directions. In down markets highly geared trusts can get stung very badly and often struggle to make their money back for some time.
2008 was a case in point, with the Private Equity sector losing over 50 per cent of its value. Trusts operating in the sector were hit particularly hard by widening discounts.
It’s worth bearing in mind that as a group investment trusts have performed very strongly over the past 10 years, so even though Private Equity has disappointed on a relative basis it’s still managed to return over 80 per cent.
The standout performer on the graph is of course the Biotechnology sector, which has blown away the competition with an annualised volatility only a touch higher than the UK Equity Income sector. FE data shows the three trusts in the sector – Worldwide Healthcare, International Biotechnology and The Biotech Growth Trust – have delivered an average return of 363.67 per cent.
Healthcare is traditionally seen as a defensive sector, but the explosion of breakthroughs in biotech has made the last decade a golden period for trusts operating in this area. Gearing and narrowing discounts have certainly helped matters.
The correlation between risk and reward breaks down almost entirely when looking at individual trusts, in part due to the reasons given above. The specialist nature of many investment trusts also plays a part, with some highly concentrated vehicles losing money but scoring highly in the volatility stakes.
Returns vs volatility for investment trusts over 10yrs
Source: FE Analytics
The graph actually discounts three highly specialist trusts, whose plus-50 per cent annualised volatility skews the scale.
It’s not all bad news though – some investment trusts have managed to deliver stellar returns with moderate volatility. Two of the leading lights in this regard are the Ruffer Investment Company and Personal Assets Trust, which are the two least volatile trusts in the entire IT universe over the last decade.
While respective returns of 129.17 and 89.16 per cent put them slightly behind the average trust, they have given investors a smooth ride along the way, which is very unusual for a vehicle of this kind. Both are multi-asset portfolios, holding not only equities but bonds, cash and alternative assets such as gold.
Further up the risk spectrum, standout performers on the left-hand side of the pack are dominated by those run by equity managers with a keen eye on downside protection.
Three equity income trusts run by FE Alpha Manager Mark Barnett – Edinburgh IT, Perpetual Income & Growth and Keystone IT – have returned between 193 and 212 per cent over the past decade, with an annualised volatility of between 12 and 14 per cent. This makes them less volatile than the FTSE All Share over the period, in spite of them being geared and suffering discount volatility.
Performance of funds, sector and index over 10yrs
Source: FE Analytics
Strong performance in the down markets of 2008 and 2011 was a particularly driver of cumulative performance, with all three making money over the latter period.
Barnett has a preference for high quality companies in traditionally defensive sectors such as healthcare and tobacco. His emphasis on sustainable dividend payers has helped them compound returns over the long term, but also smooth out the ride. The Edinburgh trust was previously run by Neil Woodford, with Barnett taking over early on in 2014.
Bruce Stout uses a very similar approach on the Murray International Trust, though this invests on a global scale. Though he invests exclusively in dividend-paying equities, he has lost money in only one calendar year over the past decade, and that came in 2008 when he beat his IT Global Equity Income sector average by over 20 percentage points.
This has helped his trust deliver almost 250 per cent over the past decade with a volatility of 15.08 per cent.
FE Alpha Manager Nick Train’s Lindsell Train IT doesn’t invest for income, making his returns of 337.15 per cent with a volatility of just over 15 per cent even more impressive. The highly-rated stockpicker invests in a concentrated portfolio of just 25 companies, targeting industry leading brands with high barriers to entry.
Though he’s had a miserable year or so, Harry Nimmo’s Standard Life UK Smaller Companies trust has still excelled on a risk-adjusted return basis over the past decade. His return of 420.16 per cent puts him well ahead of any rivals in the IT UK Smaller Companies sector, and he’s also been the third least volatile trust of its kind over the period.
Behind the all-conquering Biotech Growth Trust, which has managed an astounding 702.38 per cent over the past decade, comes two small cap emerging Asian trusts: Aberdeen Asian Smaller Companies and Scottish Oriental.
Performance of trusts, sector and index over 10yrs
Source: FE Analytics
While they’ve been by no means risk-free over the years, losing between 22 and 28 per cent in 2008, they’ve been significantly less volatile than their peers in the IT Asia Pacific ex Japan sector despite having a small cap focus. The average Asia Pacific trust lost over 36 per cent in 2008.
Much of this is down to the trust’s strict focus on investing in quality companies with strong balance sheets, predictable earnings and sound corporate governance. This approach has defined managers Hugh Young and Angus Tulloch, who are considered among the best emerging market managers on the planet.
Looking to those at the other end of the scale, specialist trusts dominate. The Blue Planet Investment Trust, for example, which has a natural bias to financials, has lost 21.87 per cent over the past decade with a volatility in excess of 40 per cent. The trust has lost more than 20 per cent in three of the last seven years, including a drop of 64.26 per cent in 2008.
Returns vs volatility for IT sectors over 10yrs
Source: FE Analytics
Looking at more traditional trusts, those focusing on Russia, Japan and private equity dominate in the bottom right hand corner. However with the exception of one or two vehicles – for example the small cap-focused Prospect Japan trust and JZ Capital Partners – all have made a profit and in most cases in excess of 50 per cent.
Some may be surprised to see FTSE 250 private equity company 3i Group in the bottom right hand corner. Though the trust has been an outstanding performer in recent years, it lost close to 80 per cent between August 2008 and March 2009. It’s up 44.99 per cent over the last decade.
FE Trustnet looked at the best open-ended funds for risk-adjusted return in an article last week.
Due to popular demand, FE Trustnet will compile the study across IA and IT sectors in the coming weeks, starting with IA UK Equity Income.
