Investment trusts have outperformed their open-ended sectors across the comparable equity peer groups so far in 2015, according to FE Analytics, with gearing and discount tightening boosting their returns in what has been a largely rising market.
Following a poor year for investment trusts in 2014 when equity market volatility was rife and investors turned increasingly risk-off as macroeconomic risks increased (the average UK trust last 2.2 per cent last year), closed ended funds have got off to a barnstorming start in 2015.
As markets have continued to climb the wall of worry and major regional indices have hit new record highs, investment trusts across the various comparable equity sectors have, more often than not, considerably outperformed their open-ended rivals.
According to FE Analytics, for example, the average UK trust has returned 11.2 per cent so far in 2015, which is 4 percentage points greater than the FTSE All Share’s gains and 1.6 percentage points than the returns of the average open-ended UK fund.
The two portfolios contain the UK All Companies, UK Equity Income and UK Smaller Companies sectors.
Performance of funds versus trusts and index in 2015
Source: FE Analytics
History has proven that investment trusts tend to outperform in rising markets due to their ability to gear, or borrow to increase potential returns, and because not only do investors see the benefit of NAV growth but also a narrowing discount when appetite for risk is high.
This phenomenon is clearly shown when you look at the comparative performance of the IT Europe sector versus the IA Europe ex UK sector and the IT Japan Equities sector versus the IA Japan sector.
Both the Japanese and European markets have rallied hard in 2015 as a result of large-scale quantitative easing programmes from the likes of the Bank of Japan and the ECB and because they were trading on low valuations going into the year.
FE data shows the IT Europe sector’s returns of 10.62 per cent and 80 basis points more than the average fund in the IA Europe ex UK sector, while the average Japanese trust has beaten its open-ended rival by more than 5 percentage points this years with returns of 19.56 per cent.
However, data from the AIC shows every trust in those two investment trust sectors is trading on a tighter discount than its one-year average.
Turning back to the UK market now, and once again the domination of trusts versus funds is all too clear to see.
According to FE Analytics, 11 of the top 12 performing UK portfolios this year are listed investment companies and, given the recent conditions, it comes as little surprise that they all have a mid and small-cap bias.
Source: FE Analytics
The standout performer has been FE Alpha Manager James Henderson’s Henderson Opportunities Trust, which has delivered hefty returns of 28.83 per cent over the past six months or so.
The closed-ended fund is a genuine multi-cap portfolio and its NAV performance has been strong at more than 18 per cent. However, is discount has narrowed significantly as well.
While its current 8.02 per cent discount to NAV is slightly narrower than its one-year average, data from the AIC shows its shares had been trading as wide as a 18 per cent discount at points over the last 12 months.
The trust is also outperforming over the longer term. FE data shows that Henderson UK Opportunities has returned 74.55 per cent since its launch in January 2007, meaning it has beaten its FTSE All Share benchmark by close to 20 percentage points.
Performance of trust versus sector and index since Jan 2007
Source: FE Analytics
However, as the graph above shows, that those returns have come with a huge amount of volatility and its recent outperformance has only really come about in the last nine months.
For example, its maximum drawdown – which measures the most an investor would have lost if they had bought and sold at the worst possible times – is a whopping 75 per cent. The FTSE All Share’s maximum drawdown has been 45.28 per cent over that time.
Other UK trusts which have performed well this year include SVM UK Emerging, Montanaro UK Smaller Companies, BlackRock UK Smaller Companies and Strategic Equity Capital.
The best performing unit trust or OEIC this year has been FE Alpha Manager Mark Martin’s five crown-rated Neptune UK Mid Cap fund. Thanks to the manager’s ‘three silo’ approach to portfolio construction, the fund is up 17.81 per cent.
This is contrary to what most people would expect from the fund though, as Martin’s focus on capital preservation means it usually only stays in line with its benchmark in rising markets and come into its own in flat or falling ones.
While UK All Companies and UK Smaller Companies trusts have outperformed their open-ended rivals, it is a strangely different story in the UK Equity Income space as the average trust has returned 5.2 per cent compared to a return of 7.84 per cent from the average unit trust or OEIC.
While the British & American IT, which is a trust of funds and trusts and largely invests outside of the UK equity market, has been the best performing portfolio out of the IT and IA UK Equity Income sectors with returns of 14.86 per cent year to date, nine of the 11 next best performers are open-ended.
Numis Securities’ Ewan Lovett-Turner says there is a key reason for that; namely discounts widening.
“The main reason is that at the start of the year the sector was on average trading on a 1 to 1.5 per cent premium and that has changed to a small discount today,” Lovett-Turner said. “If you were to look at NAV returns, they are similar to those in the open-ended sector and so the main reason for their underperformance has been that discount widening.”
He says that discounts have widened in the sector due to falling levels of demand, which seems odd that the global search for yield is still very much ongoing with interest rates at ultra-low levels.
“We have seen a lot of outflows from the open-ended UK equity sectors recently as net retail sales were very weak in the build up to the election, and that has been mirrored in the investment trust sector.”
“That was generally because of the political uncertainty but also because investors have been taking profits as the market has hit its record high.”
According to data from the AIC, half of the trusts in the IT UK Equity Income sector are now trading on wider discounts than their one and three-year average. As a result, Lovett-Turner says now is a good time to look at the sector.
“Certainly, you had to be wary of equity income trusts when they were trading on premiums and you could find better value in the open-ended sector. But now I think they look relatively attractive,” he said.
“One that we like is JP Morgan Claverhouse, which is on a 6 per cent discount. It is a good core mainstream holding for investors who are looking for diversified exposure to the UK equity market and it has performed well over recent years.”
Performance of trust versus sector and index since Feb 2012
Source: FE Analytics
Since William Meadon joined Sarah Emly as manager on the five crown-rated trust in February 2012 and changed the investment process, JP Morgan Claverhouse has been one of the best performers in the sector with returns of 68.14 per cent and has beaten the FTSE All Share by close to 30 percentage points in the process.
It yields 3.3 per cent and is one of the AIC’s ‘dividend heroes’ as it has increased its pay-out in every year for four decades or so. JP Morgan Claverhouse has gearing of 20 per cent and its ongoing charges, minus a performance fee, are 0.68 per cent.