One of the most touted features of why to choose closed-ended funds, along with long-term outperformance, is that they are deemed cheaper than their equivalent open-ended counterparts. 
While that was certainly the case before the implementation of the Retail Distribution Review (RDR) in 2012, a greater focus on cost and the advent of ‘clean’ share classes across the unit trust and OEIC sectors has seemingly challenged that long-held view.
Indeed, research from Tilney Bestinvest now shows that open-ended funds are now – on average – cheaper to buy than investment trusts.
The investment firm found that of the 47 pairs of funds and investment trust with similar mandates run by the same teams it analysed, 53 per cent of the time the ongoing charges figures (OCF) on the open ended funds were lower than those of the investment trust.
“Old and deeply ingrained generalised assumptions about different investment structures need to be fundamentally revisited given developments in the investment industry in recent years which has seen the removal of adviser commission from open ended funds, bringing down fund costs dramatically,” Tilney Bestinvest’s Jason Hollands (pictured) said.
“In the run up to RDR many saw the removal of commission from open ended funds as a one way opportunity for the investment company industry to seize a bigger share of the market when in reality the reforms have also made funds more competitive on costs, posing a new competitive threat.”
Data from FE Analytics and the AIC backs up Tilney Bestinvest’s research.
Average OCF across UK funds and investment trusts
Source: FE Analytics & The AIC
For example (and as the table shows), the average fund in the IA UK All Companies, IA UK Equity Income and IA UK Smaller Companies sectors has a lower OCF than the average trust across the IT UK All Companies, IT UK Equity Income and IT UK Smaller Companies sectors.
The picture is even worse when you include the performance fees many UK trusts charge.
However, there are always exceptions to the rule and in this article we highlight a selection of UK trusts that are still cheaper than their open-ended rivals and have outperformed over the longer term.
IT UK All Companies
One of the cheapest options in the IT UK All Companies space is the Mercantile Investment Trust, with its ongoing charges of 0.5 per cent making it 51 basis points less expensive than the average IA UK All Companies fund.
The trust, which is managed by Martin Hudson, Anthony Lynch and Guy Anderson, invests outside the FTSE 100 for opportunities and has a track record of beating the wider market over the longer term.
According to FE Analytics, it has returned 125.21 per cent over 10 years meaning it has beaten the FTSE All Share, the IA UK All Companies sector and its own peer group average by 50 percentage points or more over that time.
Performance of trust versus sector and index over 10yrs
Source: FE Analytics
It is also outperforming over three and five years, though thanks to its mid-cap bias, Mercantile has struggled over 12 months with losses of 0.06 per cent as investors have favoured international-facing large-caps.
Most of its outperformance has come during rallying markets as the trust has tended to fall far harder than the wider market in times of stress – such as in 2007, 2008 and 2011.
However, its recent underperformance means the trust – which isn’t geared and counts the likes of Dominos Pizza, Just Eat and Auto Trader as top 10 holdings – is now trading on a 10 per cent discount to NAV, which is far wider than its one and three year average.
Other IT UK All Companies trusts that have lower OCFs than their equivalent open-ended funds (and don’t charge a performance fee) include Schroder UK Growth, Schroder UK Mid Cap and Woodford Patient Capital.
IT UK Equity Income
One of the highest profile cheap trusts in the popular IT UK Equity Income sector is the Edinburgh Investment Trust, following a decision from the board to lower the annual management charge over recent times.
It now has ongoing charges of 0.61 per cent, a figure which is 32 basis points lower than the average OCF in the IA UK Equity Income sector.
Edinburgh had previously been managed by Neil Woodford prior to his departure from the group and is now run by FE Alpha Manager Mark Barnett, who took charge of the portfolio in January 2014. Barnett had a decent long-term track record before he took on the role of head of UK equities from Woodford and that form has only continued since he took charge of the £1.4bn portfolio.
Indeed, under his stewardship, Edinburgh has been the second best performing member of its peer group and beaten every fund in the IA UK Equity Income sector with returns of 36.68 per cent. That compares to a 15.55 per cent return from the FTSE All Share.
Performance of fund versus sectors and index under Barnett
Source: FE Analytics
The portfolio is very similar to Barnett’s Invesco Perpetual High Income and Income funds with high weightings to the likes of the tobacco and healthcare sectors as the manager uses the same total return approach.
While its yield is low compared to the market at 3.39 per cent, the board has a good track record of growing the dividend. It is currently trading on a wider than average 1.45 per cent discount to NAV and is geared at 14 per cent.
Other IT UK Equity Income trusts that have lower OCFs than their equivalent open-ended funds (and don’t charge a performance fee) include The City of London IT, Temple Bar and Finsbury Growth & Income.
IT UK Smaller Companies
The UK smaller companies space is where you find the largest difference in OCFs between trusts and funds (51 basis points) and therefore, unsurprisingly, there are very few closed-ended small cap funds that are cheaper than the average IA UK Smaller Companies fund.
Indeed, there are only four in the sector that have ongoing charges lower than 1.08 per cent. One of those is Henderson Smaller Companies trust.
It is the cheapest portfolio in the peer group with ongoing charges of 0.47 per cent and while it does enforce a performance fee, the AIC calculates that its OCF plus performance fee only amounts to 0.89 per cent – so 19 basis points lower than the IA UK Smaller Companies sector average.
Neil Hermon has run the portfolio since November 2002 with a focus on companies with strong balance sheets and decent growth potential.
According to FE Analytics, it has beaten all but four IT UK Smaller Companies and IA UK Smaller Companies portfolios over that time with returns of 857.65 per cent, meaning it has outperformed its Numis Smaller Companies ex IT benchmark by a hefty 376 percentage points in the process.
Performance of trust versus sectors and index under Hermon
Source: FE Analytics
It is also outperforming its benchmark and the average open-ended UK small cap fund over three and five years and has beaten the wider market in seven of the last 10 calendar years – the exceptions being the harsher market conditions of 2007, 2008 and 2011.
Henderson Smaller Companies is also struggling over more recent times as investors have shunned UK small caps both prior to and after the Brexit vote, meaning the trust has lost some 10 per cent already in 2016.
This means, though, that its shares are trading on a 14.48 per cent discount to NAV – a figure which is significantly wider than its one and three year average.
The trust is 7 per cent geared and has a dividend yield of 2.4 per cent.
