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Investment trust or open-ended fund in volatile markets?

24 November 2020

As market volatility continues amid the Covid-19 pandemic, investors need to think carefully about whether to opt for an investment trust or open-ended fund equivalent, according to Quilter fund expert Nick Wood.

He says: “Today, many investment trusts that invest in equities have an equivalent in the open-ended world. These might be exact mirrors, with the same holdings, or they may be run by the same team but have some nuances, often caused by the greater freedom a trust structure can provide. Like any investment, making the right choice between an open-ended fund and its mirrored trust isn’t necessarily easy. Knowing how much they differ is important in assessing any differences in relative risk.”

Wood’s comments come after the Baillie Gifford China Growth Trust recently ballooned to a 30% premium, prompting Wood to note that new investors would be buying a pool of assets whose fair value is considerably lower. However, investors could gain access to nearly the exact same strategy and management team in an open-ended fund equivalent, which are purchased at net value meaning investors do not have to endure the risks of premiums or discounts.

According to Wood, there are five key things investors should consider when choosing between an investment trust and an open-ended fund.

Arguably the most important, according to Wood, is where the discount or premium sits for an investment trust today, with “bargains to be had” when trusts trade at a large discount.

“For most of this year, investors love of growth investments had left many of the more value-biased trusts looking attractive. One such was Fidelity Special Values, managed by Alex Wright, who has an excellent track record, but who had struggled of late.

“Having generally traded on a premium in recent years, it had moved to a significant discount, as wide as 12% at one point, and clearly that was a good chance to buy the trust over the open ended,” said Wood.

Investors should also consider risk versus return, and the impact of gearing, or additional borrowing.

And while it’s often thought that a benefit of investment trusts is that they do not suffer issues caused by investor outflows that may impact an open-ended fund due to their different structure, Wood warns that this is not always the case.

He explained: “We did see in the extreme event of the Neil Woodford fall-out how trusts with a large mirrored open-ended equivalent can impact the share price, at least in the short term. Any commonly held investment, especially those less liquid holdings, will potentially be impacted by a persistent seller in the market, in this case the mirrored open ended fund. Being aware of what is happening with the mirrored open-ended fund is vital for investors.”

Another factor to bear in mind, according to Wood, is the ability of trusts to hold reserves and to supplement dividend payments when needed during more volatile times. For income-seeking investors, buying a trust over the open-ended fund might be a wiser move if they are concerned about retaining a certain level of dividend pay out.

Finally, investors should consider the cost and acknowledge that there will be some meaningful differences between some trusts and their equivalent funds. Wood said investors should be mindful and “do their homework and don’t overpay.”

Professional Paraplanner