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Mirror, mirror on the wall, which is the fairest fund of all?

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Mirror, mirror on the wall, which is the fairest fund of all?

This question is not as daft as it seems when many millions of pounds are invested in so-called 'mirror funds'. These are pooled funds run by the same individual manager and the same – or very similar – investment aims but with very different charges and performance figures.

Lest anyone think gazing into these mirrors is a tedious technicality, let me say straightaway that new research exclusive to Citywire shows that mirror funds with lower charges often deliver higher returns to investors. There’s nothing trivial about that.

Regular readers will have guessed by now that I am talking about investment trusts – or closed end pooled funds – and unit trusts – or open-ended investment companies (Oeics) - which are virtually identical in branding, leadership and objectives but very different in structure and outcomes for the end user or individual investor.

Mirror funds are one of the most curious quirks of the investment industry. More than £2 billion is invested in some of them but it is difficult to explain why they exist.

Even more mysteriously, there is far more money invested in the higher-charging funds that deliver lower returns. It is difficult to see how this benefits individual investors but easy to see what is in it for the fund management groups.

This is the sort of thing the Financial Conduct Authority ought to investigate but the City watchdog shows no interest in doing so. The FCA really should change its acronym to SFA for all the good it does anyone outside its expensive offices.

Now Jason Hollands, managing director of Tilney Group, has identified several pairs of mirror funds from big management groups where five years of past performance show investors obtained higher returns for lower costs. Better still, they could benefit from buying shares in these investment trusts today at a discount to their net asset value.

Step forward Fidelity European Values (FEV) investment trust which has a market capitalisation of less than £800 million and its £2.3 billion mirror Fidelity European. The former fund delivered total returns of 96% over five years compared to 81% from the open-ended rival but the investment trust trades at a discount of 11.7%. Both are managed by Sam Morse.

Then there’s Henderson Smaller Companies (HSL) investment trust and Henderson UK Smaller Companies. The closed-end trust has soared by 164% while the unit trust is up 131% but the laggard charges nearly twice as much per year as the better performer; 0.85% compared to 0.44%. The investment trust trades at a 15.7% discount. Both are managed by Neil Hermon.

Invesco Perpetual UK Smaller Companies (IPU) did best of all among these three pairs, delivering 167% over five years, compared to 131% for its open-ended rival Invesco Perpetual UK Smaller Companies Equity. The former fund has ongoing charges of 0.8% compared to 0.92% for its mirror. Jonathan Brown manages both.

Hollands has other examples but these mirrors make the point. In all these pairs, trust discounts will erode or even exceed the cost of switching from one mirror fund to another.

How’s that for a practical solution to a complex problem? Yes, I know asset allocation within these mirrors may vary and some trusts use gearing, which increases risks and returns. But leaning too heavily on those arguments looks very like trying to fill the room with smoke.

Hollands and Tilney deserve praise for scrutinising investment trusts and unit trusts on an equal footing, without prejudice about one format or another. Elsewhere, the wealth management industry should take a long hard look at mirror funds and ask itself whether it is really treating its clients fairly. Is it putting their interests first, second or third?

Anyone hoping the industry’s moribund regulator might take an interest in this multi-million pound scandal should not hold their breath. But, remember, when a mirror breaks it might bring many years bad luck.

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