Active investment managers have been on the retreat since November when the City watchdog published an excoriating report, accusing them of peddling expensive, poorly performing funds.
In its interim report on the asset management sector the Financial Conduct Authority said its analysis showed that retail funds failed to beat their stock market benchmarks after costs.
It also said it could find no clear relationship between price and performance, adding that ‘the most expensive funds do not appear to perform better than other funds before or after costs’.
These devastating conclusions were widely seen as giving a massive endorsement to cheaper, ‘passive’ index-tracking funds, most notably exchange traded funds. ETFs have attracted ever-rising volumes of money as investors grow tired of the apparently unreliable stock pickers in charge of their savings.
‘Astounding’ 90% victory
New research from Lewis Aaron of Fund Consultants for Aberdeen Asset Management, an investment trust manager, challenges this analysis, however, in relation to investment trusts and investment companies listed on the London Stock Exchange.
There are nearly 400 of these ‘closed ended’ funds with over £160 billion assets under management. Following the proposed merger of Aberdeen UK Tracker (AUKT) with Aberdeen Diversified Income and Growth (ADIG), this sector won’t have a single index tracker fund and so is a good proxy for active fund management.
Aaron, a former investment trust analyst at Swiss bank UBS, is a renowned number cruncher, founding and later selling his company Fundamental Data to Morningstar, the leading provider of investment trust performance data.
Wanting to see whether the FCA was right to condemn all active funds, Aaron gathered the performance data of all investment trusts and around 1,500 exchange traded funds, and sorted them into 19 comparable sub-sectors.
As the table below shows, Aaron found that over ten years, the weighted average returns from investment trust portfolios beat their ETF rivals in nine out of 10 sectors, an achievement he considered ‘astounding’ (nine of the 19 sectors not having ETFs with records going back 10 years).
Trusts are active champions
Perhaps not surprisingly, the notoriously efficient and competitive US stock market was the one area where ETFs narrowly beat investment trusts. In ‘US Equity Large Cap Blend’ – a sector covering funds investing in big US firms with a ‘blended’ value and growth investment style – investment trusts generated a total return of just over 200%, behind ETFs which achieved just over 2008%.
Otherwise, in the UK, Europe, Global, sterling fixed income bonds and a range of emerging market sectors, investment trusts beat their passive ETF rivals. Admittedly, not by much in the UK Equity Mid/Small Cap sector, although the outperformance in Europe, Asia, China and other emerging markets is more impressive.
‘Using investment trusts as a proxy for active management and ETFs as a proxy for passive, our results contradict current thought that active management outperforms, and therefore should be shunned,’ said Aaron.
Aaron also believes his findings quash what he called the ‘red herring’ of fund charges.
‘All returns of both groups of funds are shown net of all expenses, and therefore focusing on the expense element without considering the return element is false and misleading.
‘This is akin to analysing a company’s expenses whilst ignoring their turnover, a nonsensical exercise,’ he said.
Investment trusts vs ETFs: the results
|Sub-sector||Investment trust NAV 10-year total return %||ETF 10-year total return %||Investment trusts beat ETFs?|
|Europe Equity |
|Europe Equity Mid/Small Cap||141.3||80.9||Yes|
|Global Equity |
|Sterling Fixed Income||98.8||69.6||Yes|
|UK Equity Mid/|
|US Equity Large |
|Asia ex-Japan Equity||182.8||133.9||Yes|
|Emerging Markets Equity||113.8||67||Yes|
|Greater China Equity||180.2||76.8||Yes|
Source: Morningstar Inc, Fund Consultants LLC 6/3/2017. Sector weighted averages used. Performance shown after fund charges but do not include the costs of a broker or investment platform to buy them.
Sectors not in the table because there was no 10-year data but included in Fund Consultants' study were: Canadian Equity, Energy Sector Equity, Global Equity Mid/Small Cap, Healthcare Sector Equity, Japan Equity, Technology Sector Equity, UK Equity Large Cap, US Equity Small Cap and Africa Equity.
You don't get the 'NAV'
There are of course a couple of caveats.
The first is that over shorter periods the gap between investment trusts and ETFs narrows considerably.
Nevertheless, investment trusts remain in the ascendant: over both five and three years to 6 March, 2017, trusts beat ETFs in 13, or 76%, of 17 eligible sectors; falling to 10, or 53%, of 19 sectors over one year.
The bigger caveat is that Aaron’s analysis is based on the net asset value (NAV) returns of investment trusts. This measures the performance of their underlying portfolios in the hands of their active fund managers, not what their shareholders actually receive.
Nevertheless, the study does show that through a combination of active stock picking and gearing (the borrowing that many investment trusts use to boost returns), investment trusts are proven to deliver better performance than ETFs that simply buy, or replicate, every stock on an index and are mostly ungeared.
In reality investment trust shareholder returns often vary greatly from their underlying NAV performance because their shares often trade at discounts (below) or premiums (above) their net asset value.
Still, the study does provide some reassurance to investors in investment trusts. Provided their boards and fund managers apply the same skill on marketing their trusts and managing their share prices as they do on running the portfolios, the end result should be a positive one.
How to deliver above-market returns to the growing number of people saving for their retirement is a huge challenge but the FCA should not have been so quick to give the impression that is impossible to achieve - at least, not without showing the data behind its analysis first.