Investment trusts have outperformed funds in most major sectors over ten and twenty years

Investment trusts have beaten funds on returns in most major sectors over ten and 20 years – but can you still find a bargain as discounts narrow?

  • New research from Interactive Investor has found investment trust sectors have outperformed most of their open-ended counterparts over ten and 20 years
  • UK Equity Income trusts have outperformed UK Equity Income funds by an average of 1.79 per cent over ten years and 1.5 per cent over 20  
  • The platform warned narrowing discounts mean its harder to find a trust bargain 

The average investment trust has beaten its fund equivalent on returns since 2000, according to new data from Interactive Investor. 

It found that most of the major investment trust AIC sectors, including Global, UK Equity Income and UK All Companies trusts, outperformed their Investment Association fund counterparts for average annual returns over both 10 and twenty years.

But the DIY investing platform said investment trust discounts have narrowed so it may harder to find a bargain at the moment by getting a share of a basket of assets for less than their total value.

Interestingly, the only major sector where funds beat trusts was UK smaller companies – an area where investors might think investment trusts might benefit due to their structure.

New research suggests the average trust has outperformed its fund equivalent since 2000

Both investment trusts and active funds have a manager and invest across a variety of companies or assets, but there are a number of differences between them.

Funds are open-ended and grow or shrink in size as more money is put in or taken out by investors. Whereas, investment trusts are a stock market-listed company in their own right and have shares, so are limited in size unless they issue more shares.

The advantage of this is that investment trusts do not become either a forced buyer or seller, as a fund can if it has too much money rush in or out from investors.

Investment trusts can also borrow to magnify returns, known as gearing, however, this can also exacerbate losses. As a company, trusts also have boards keeping an eye on managers.

But investment trusts’ share prices can sometimes trade at a discount or a premium to the sum of their parts, depending on sentiment and investor demand. 

The results of Interactive Investor’s research shows that a diversified portfolio -potentially including both open and closed-ended funds – pays off.

The average global investment trust outperformed the average global fund by almost 1 per cent a year on average over the past 10 years, and by 2.62 per cent per year over the last 20 years. 

The Association of Investment Companies and the Investment Association are the trade bodies for the UK’s investment trusts and investment funds, respectively. Products listed on their platforms are split into their relevant sectors.

For example, a fund focused on creating income by investing in UK stocks will sit in the Investment Association’s UK Equity Income sector.

This sector is another investor favourite, and the average UK Equity Income trust outperformed the average equivalent fund by 1.79 per cent per year over 10 years and 1.5 per cent per year over 20 years. 

Meanwhile, investment trusts in the European Smaller Companies sector outperformed funds by 3 per cent a year over 10 years and 2.43 per cent over 20 years. 

The only sector where funds trumped trusts was UK Smaller Companies, where the average fund has outperform the average trust on an annualised basis by 2.35 per cent per year over 10 years and 0.58 per cent per year over 20 years. 

Sector 10 Years Annualised % 10 Years Cumulative % 20 Years Annualised % 20 Years Cumulative %
IA Global 9.66 151.5 5.68 202.1
AIC Global 10.61 174.22 8.3 392.98
IA UK All Companies 6.37 85.45 4.65 148.01
AIC UK All Companies 6.64 90.2 6 220.56
IA UK Equity Income 6.1 80.79 4.92 161.54
AIC UK Equity Income 7.89 113.74 6.42 247.19
IA UK Smaller Companies 10.87 180.77 7.82 351.03
AIC UK Smaller Companies 8.52 126.59 7.24 304.52
IA Europe Excluding UK 8.01 116.06 5.61 197.68
AIC Europe 8.58 127.75 7.87 355.34
IA European Smaller Companies 10.3 166.69 8.14 378.53
AIC European Smaller Companies 13.37 250.67 10.57 645.46
IA Asia Pacific ex Japan 8.46 125.19 9.56 520.77
AIC Asia Pacific 15.68 329.29 13.97 1,267.69
Source: Interactive Investor using Morningstar/IA/AIC. Figures as at 31 January 2021.

Beware narrowing discounts and watch individual performance

Interactive Investor has said investors should be conscious of narrowing discounts in the trust universe. 

While untl relatively recently investment trust double-digit discounts were the norm, today they are more of an exception and bagging an investment trust bargain is easier said than done. 

Dzmitry Lipski, head of funds research, at Interactive Investor, said these figures are also just averages and that there will be a mix of winners and losers in each sector.

He added: ‘Investment trusts do have some structural features that help them outperform over the long term, such as the ability to gear to enhance returns, and a closed-ended structure that means they can take a long-term view without having to sell stock to meet potential redemptions. 

‘But their ability to gear to enhance returns also means they can be considerably more volatile in falling markets.’

Discounts and premiums 

Investors should also consider investment trust discounts, which have narrowed significantly over the past ten and twenty years. 

Discounts in the context of investment trusts are a function of the stock market and the simple laws of supply and demand.

In basic terms, when an individual investment trust’s shares are proving popular with investors, it can result in them trading above the value of the trust’s underlying assets. When this happens, the shares are said to trade at a premium to asset value.

This is a function of buyer demand driving up the share price and is currently occurring with some renewable energy trusts.

Yet when an investment trust’s shares are unpopular, the opposite happens. A lack of demand means shares can end up not reflecting the value of the trust’s assets. In other words, they trade at a discount. 

Discounts in the investment trust world result from a number of factors – a particular investment theme falling out of favour; an investment trust manager delivering poor performance numbers relative to the opposition; or, as has happened recently, the stock market going into meltdown. 

In the wake of the coronavirus pandemic, the discount on the average investment trust widened to 25 per cent – larger than the 18 per cent in the 2008 financial crisis.  

Lipski added: ‘Wide discounts mean you get more capital and income working for you to produce long term returns, but for new investors buying today, that opportunity has vanished – at least for now.

‘The early days of the pandemic last year did see investment trust discounts, on average, return to the high teens – but not for long.’