With the RDR squeezing open-ended funds’ prices, how do clean share classes compare with investment trusts?
Over the past five years the top UK Equity Income investment trusts have surged ahead of open-ended counterparts in return but performance fees have pushed the average cost higher than Oeics and unit trusts.
The share price total return of the top five trusts ranged from 168.9 per cent to 119.3 per cent over the five years to 26 November, according to AIC data.
The top five performing open-ended funds over the same time frame returned between 135.9 per cent and 96.2 per cent, according to FE Analytics.
The closed-ended trusts would have benefited from the leverage they can apply to ratchet up returns as well as share price swings.
JP Morgan Investment Trusts sales head Tim Mitchell says the performance of investment trusts makes up for the extra cost.
The 17 basis point difference between the average costs of the top five performing investment trusts and their open-ended rivals is small compared to the benefit, he says.
“When you think about it, the 17bps difference is miniscule,” he says. “It’s another average day of market movement on a quiet day.”
The RDR’s clean pricing has stripped out commission, making open-ended fund pricing more comparable to closed-ended and narrowing the historic price advantage of underlying charges, Mitchell says.
“In many respects you could argue that ‘what is the right fee?’ is the hardest question to answer and it depends who you ask.
“But there’s a consensus forming that if you deliver something like the index, people are going to be asking why they should be paying you active fees for something that offers a very passive performance.”
There could be an argument for lower base costs with a reasonable performance fee for outperformance. That way, fund managers are paid for the value they create rather than essentially collecting a rental stream.
The average charge for AIC UK Equity Income trusts, excluding performance fees, is 73bps, much lower than the 94bps cost of their open-ended equivalents.
Including performance fees the average investment trust charge leaps to 97bps.
That means an investor in an average trust will pay much less for underperformance than an owner of Oeics and unit trusts, and just a few basis points extra on average for outperformance.
That average performance fee-inclusive cost may have been dragged down by poorly performing trusts that did not hit the targets necessary to take their bonus.
Of the top five performing trusts over the past five years, the top-returning trust, Finsbury Growth & Income, does not have a performance fee. Meanwhile, the Perpetual Income & Growth cost 1.85 per cent for returns of 144.50 per cent.
Lowland, meanwhile, comes in at 90bps for 161.1 per cent return inclusive of its performance fee.
“Performance fees become more complicated for Oeics so many just don’t do it,” Mitchell says.
The trend is away from performance fees rather than towards them, he adds.
JP Morgan manages 25 investment companies, of which eight have performance fees.
Hargreaves Lansdown head of investment analysis Richard Troue says the boosted returns of the investment trusts would have come with costs beyond the management fees.
“You also need to remember the extra risk you’ve taken for that return. What you’ll probably find is the investment trusts have delivered quite a bit more return than the open-ended funds. But once you factor in the additional costs for performance and the increased volatility you’re probably adequately rewarded for that risk, but only just.”
The past five years were devoid of serious, sustained setbacks in the markets which would benefit investment trusts more than Oeics, he adds.
However, over a period that includes a downturn, the leverage and share price mechanisms would work in reverse and could moderate the out-sized returns of a bull market, he says.
Investment trusts have been historically slightly cheaper than open-ended funds, but the price gap has narrowed since the RDR, Troue adds.
“Headline AMCs have been coming down a bit for Oeics and that has eroded some of the cost advantage that investment trusts have had in the past.”
He believes trusts could regain some of the lost ground by ditching performance fees or dropping the headline management charge to compensate investors for the performance fee.
He admits that with a low enough headline rate and a robust performance fee for delivering the goods, investors could be better off.
However, Troue would rather see a simple, single charge that is more comparable and accessible for investors.
“In too many cases performance fee criteria have not been robust enough or challenging enough to provide a significant hurdle,” he says. “So quite often managers have been earning a performance fee for what most investors would consider to be just inside their area of duty really.”
Axa Wealth head of investing Adrian Lowcock says he would rather see performance fees fall by the wayside as well.
While some trusts have been ditching performance fees, some – but not all – have been boosting the headline management charge in return, he says.
“But if you can deliver excellent outperformance continually – obviously not to the point of being a Ponzi scheme – but a regular annual record or at least over a rolling period, people will pay higher fees for above market returns.”
He says the two products are too different to compare.
In the main, investment trusts have higher volatility because of the sentiment of the share price adding to the leverage they can take on, he says.
That means, all else being equal, a UK Equity Income investment trust is likely to be a riskier investment than its open-ended counterpart, he says.
“But, on the flipside, for highly illiquid assets such as property investment trusts can actually reduce risk.”
Investment trusts are likely to always be cheaper than open-ended funds because they do not have the administrative expenses of daily dealing and accompanying liquidity trading, he says.
“I think that’s a general view that those costs will get closer and closer with technology lowering the costs for unit trusts.”