A review of 2016: A test of endurance…


2016 is certainly a year that will go down in the history books – for both the right and wrong reasons.

Apart from a swathe of celebrity deaths, we’ve had Brexit, the still surreal rise of Donald Trump and let’s not forget Leicester City’s campaign which saw the Midland’s side defy their 5000-1 odds to win the Premier League.

However, while historians, political scholars and footballs fans will undoubtedly go through 2016 with a fine-tooth comb for generations to come – it seems it is a year that investment trust enthusiasts will want to forget in a hurry.

In our detailed review of the performance of closed-ended funds versus their open-ended counterparts (illustrated below), we have found that investment trusts have largely struggled to make any headway in 2016’s manic market conditions. We have analysed the 10 major IT equity sectors against their Investment Association open-ended (OE) equivalent as well as a comparative benchmark index (shown in the table below). While not all trusts are benchmarked against the indices we have used, these are the most commonly used benchmarks in the relevant sectors and, let’s face it, are indices investors would hope their trust can beat over the longer term.

review-1As we highlight below, most trusts have struggled to outperform this year and in this research we attempt to pinpoint why that has been the case. However, during our research, we have found that 2016 has proved to be somewhat of an anomaly as longer term, trusts have added value against both the OE peers and their benchmarks.

2016 – A year to forget for investment trusts

Though we looked at performance between January and the end of November 2016, there is no point beating about the bush, 2016 is proving to be a forgettable one for trusts.

According to our research, in seven out of the 10 sectors we analysed, trusts have underperformed their open-ended equivalents in NAV terms over 2016 to the end of November and the average underperformance has been 1.31 percentage points at a sector average level.

Performance of trust and fund sectors in 2016

review-2Source: Morningstar *in percentage points

The three areas where the ‘average’ trust has beaten the ‘average’ fund in NAV terms are Asia Pacific ex Japan, North America and UK Smaller Companies – though when looking in share price terms, it is only Asia Pacific and North America.

So, why has that been the case? Well, first and foremost, it has been a terrible year for active managers. Indices have rallied around the world (in sterling terms, anyway) despite the clear headwinds that have persisted and, due to a variety of reasons, active managers have failed to keep pace.

For example, it is only in North America space where the ‘average’ trust has beaten its comparative benchmark index, while only 32% of all the trusts we analysed (130) have outperformed. What’s more, the average underperformance of trust relative to their indices is 3.84 percentage points – a wide margin for what is a fairly short period of time.

Performance of trust sectors versus indices in 2016


Source: Morningstar

It is in areas such as the UK and global emerging markets where this theme is most apparent. Both the FTSE All Share and the MSCI EM indices have delivered double-digit gains so far this year and have been driven by the performance of previously bombed out mega-caps as sterling’s falls along with looser monetary policy have provided a currency/liquidity-injected boost.

In the IT UK All Companies and IT UK Equity Income trust sectors, only four out of a possible 38 have been able to beat the FTSE All Share, while only three out of 11 GEM trusts are beating the MSCI EM index.

But, it’s not been plain sailing for OE funds either…

However, this trend has also been a problem for OE funds – albeit to a lesser degree.

While the IA Japan sector is the only peer group where the average return has been higher than the comparative index (which is worse than in the IT space), the average underperformance of those sectors relative to indices has been ‘better’ at 2.53 percentage points.  

Performance of fund sectors versus indices in 2016


Source: Morningstar

There are various reasons why the ‘average’ fund has beaten the ‘average’ trust this year.

Firstly, those OE sectors include a significant proportion of trackers (whereas you only, apart from one exception, find actively managed trusts) and this will have undoubtedly boosted performance as if more of your constituents mimic the index in a year where indices have generally rallied, you are going to fare well. For example, if you take out the 38 passive funds in the IA UK All Companies sector which totals 275 portfolios, the proportion of funds beating the FTSE All Share falls from 25% to 19%.

Secondly, though, many of the best performers in those OE sectors (especially in areas where the index has rallied substantially) are holding the stocks and sectors that had a very painful 2015 and have witnessed significant mean reversion. The UK is very good example of this.

Data from FE Analytics shows, for example, that the average return from the IA UK All Companies funds that have beaten the FTSE All Share so far this year was 7 percentage points lower than the sector average over the three years between 2013 and 2015. In 2015, those funds – on average -returned just 0.27% compared to a 1.79% rise in the FTSE All Share and a 4.86% from the sector average – with only 30% of those funds (which are largely value-orientated portfolios with a high weighting to the likes of mining and energy) able to beat the index last year.

The performance of the SLI UK Equity Recovery fund – which holds c20% of its assets in Barclays, Glencore and Anglo American – highlights this trend perfectly, having been the best performer in the sector this year with returns of 40%, but among the five worst performers last year with losses of 6%.

This theme isn’t limited to the UK – around the world we have seen 2015’s ugly ducklings witness serious bouncebackability.

A hangover from 2015?

The performance of trusts this year can, largely, be attributed to markets being turned on their heads. Let’s not forget, 2015 was a year where indices struggled to make any real ground as uncertainties caused by China’s slowing growth and currency devaluation as well as falling commodity prices weighed heavily.

As such, it proved to be a stellar year for active managers as (in most instances and especially the UK) if you avoided the largest members of the index, you outperformed.

Taken on average, trusts can afford to me more ‘active’ than their OE equivalents due to their structures (such as a closed pool of capital and therefore no risk of outflows) and tend to have higher weightings to less liquid areas of the market – and 2015 proved to a year where they mainly outperformed. In six out of the 10 sectors, trusts beat their comparative indices and their OE rivals last year. In fact, trusts, on average, outperformed funds by 1 percentage point last year while 65% of the trusts we analysed beat their comparative benchmarks – again a higher figure than in the OE universe.

Performance of sectors versus indices in 2015


Source: Morningstar  

As such, many trusts – where turnover is generally lower than in OE funds and most are still holding last year’s winners in the hope of longer term outperformance – are simply enduring the hangover of a fantastic 2015. A good example is in Japan as in 2015, all five trusts outperformed the Topix. This year, however, only 1 is outperforming.

Effectively, what we have seen this year is mean reversion of the highest order. Will the largest constituents of the index continue to drive the market and active managers, especially in the trust space, continue to struggle? Who knows. However, investment trusts still dominate over the longer term

Ten-year domination…

For example, in all 10 sectors, trusts have outperformed OE funds over the past 10 years to the end of November. What’s more, the average outperformance of the ‘average’ trust relative to the ‘average’ fund over that time is a stark 20 percentage points.

They also stack up very well against their respective indices. In six out of the 10 sectors, trusts have outperformed their comparative indices and the average outperformance is 6 percentage points, while some 58% of all the trusts we analysed are outperforming the index over that time.

Performance of sectors versus indices over 10yrs



Source: Morningstar

As the table shows, OE funds have added significantly less value. Out of the 10 sectors, it is only the IA UK All Companies and IA Europe ex UK peer groups where the average return has been greater the index over that time. Also, across those sectors, OE funds have underperformed their comparative indices by 13 percentage points over the past decade while only 43% of the 696 OE funds we analysed have beaten their comparative index.

So, trusts have kept their title of the long-term vehicle for outperformance, despite what has turned out to be an ‘annus horribilis’ for the closed-ended structure.



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