Confused about the difference between investment trusts and investment companies? Read our What's In a Name? explanation.
In keeping with the ghostly spirits of Halloween, we’ve taken a look at a number of investment fund options that have both an open-end fund and a ghost, or “shadow”, investment company equivalent to see whether choosing the lesser-known closed-end version can produce a better return for the investor.
The criteria for our selection were that both the open-ended fund (OEIC) and its equivalent closed-end investment company fund must be run by the same manager or team; that both must use the same investment process; that the underlying holdings of each must show a close match; and that the OEIC fund must carry a Morningstar qualitative rating.
For those readers unconvinced by closed-end funds or investment trusts, our findings make for chilling reading.
In this, part one, of our ghostly tales, we highlight two spine-tingling investment performances that bring investment trusts out of the shadows and upfront and centre among some of the better performers in their sector.
Our first spine-tingler comes from the house of Aberdeen.
Both Dunedin Smaller Companies (DNDL)--an investment trust--and its OEIC mirror Aberdeen UK Smaller Companies are run by Aberdeen’s pan-European Equity team, and benchmarked to the FTSE Small Cap ex-IT index.
Here’s how both the investment trust and the OEIC performed in percentage terms over the five-year period September 30, 2005 to September 30, 2010 (for the investment trust we show both price and NAV performance).
The difference in returns is substantial.
Aberdeen UK Smaller Companies carries a Standard rating from Morningstar, which means that whilst we don’t think this fund will do investors harm, neither do we think it will serve them particularly well. Indeed, we like the team at Aberdeen, but we are not convinced that the process they employ here works to the fund’s best advantage in the developed world: we think it works better in developing countries. In addition, both funds are similar in size--Dunedin’s total assets are around £77 million, Aberdeen UK Smaller Companies £105 million.
So what accounts for the better performance for shareholders in Dunedin? Gearing.
Gearing is a concept that frightens many investors, but their fear centres around a lack of knowledge. If used well, gearing enhances returns in rising markets. In falling markets, however, the story is more ghoulish, as it exaggerates the downside too.
The team at Aberdeen instigated gearing in the investment company when they took over at the start of 2006 and have kept it geared almost constantly over this five-year period. Far from being a horror story, the act of gearing has worked like a charm.
Our second spine-tingler is a tale from Standard Life. Standard Life UK Smaller Companies comes as both a closed-end investment company and an open-ended fund, both managed by the same team.
If you bought the OEIC five years ago, you’ve done very well; if you bought the investment company, you’ve done even better.
The OEIC carries our top qualitative rating of Elite; led by Harry Nimmo, the Edinburgh-based team at Standard Life is responsible for around £1.2 billion in assets. It’s one of the most stable teams we’ve seen in this space and their process is well applied in a disciplined manner.
Part of the outperformance by the investment company is down to fund size. The OEIC is £784 million, whereas the closed-end version is a much more modest £121 million, which makes it more nimble. That said, the team is running a chunk of assets in this way and they don’t trade heavily, so the benefit of a smaller fund size isn’t the only reason.
Fees play a part too--the latest total expense ratio for the OEIC is 1.59; the investment trust is 1.19. That 40-bp difference compounds nicely over five years.
But, again, a key factor is the manager’s effective use of gearing. Nimmo and his team eased off the gearing of the closed-end version into the latter half of 2007 and by the time the market crashed in September 2008 they had stopped gearing altogether. They turned it back on just after the market rally began and have kept it modestly geared since then.
The expertise of running a closed-end investment company and using gearing well really shows through in this fund, and they navigated the liquidity problems well, too.
All in, there’s little to differentiate the two funds, other than lower fees and better returns in the closed-end investment company.
So, with Halloween upon us, the question is, will this chilling tale of open-ended fund investors losing out on the extra outperformance enjoyed by those investing in the closed-end equivalent encourage a look into the shadows? These examples from Aberdeen and Standard Life might suggest some merit for doing so.
