There are really only three simple reasons why most experienced investors should buy closed-end investment trusts.
The first most obvious one is that well managed closed-end funds should outperform passive funds. The next obvious reason is to buy into specialist alternative asset classes where there is no realistic passive option – this is especially true of alternative sources of income. The last reason is to buy a bunch of quality assets on the cheap, by buying into a well-managed fund on a discount.
The good news is that we should be able to measure each of these considerations in a fairly systematic, quantitative fashion.
In terms of alternative assets, IPO and placing data suggests that the world of closed-end funds is in fine form – we’ve seen an unprecedented flood of money into the sector over the last 18 months.
Data on the other two reasons for buying into investment trusts comes from a report out this week by Alan Brierley and Ben Newell at Canaccord Genuity. In their report entitled “Performing well but no room for complacency” Brierley and Newell dish the dirt on discounts and alpha.
The bad news centres on the data relating to discounts – they’re currently as tight as they’ve been for many years. Brierley and Newell observe that “In terms of “expensiveness”, the weighted average equity investment company discount has now ranked in the 99th percentile over the past 20-years: A widespread re-rating has taken the weighted average discount to just 3.6% at the end of January. To put this in context, there have only been 17 days in the past 20 years when the weighted average discount has been narrower. So far this month, the average discount was widened to 3.7%. A high degree of correlation between discounts and equity markets has been a feature of the past decade. In the event of more challenging market conditions, we would expect this relationship to continue.”
What about “alpha” within the investment trust sector? On this score, there’s much better news. Their data suggest that a whole range of specialist funds have in fact been outperforming their passive peers – according to the Canaccord analysts “ Over five years, 64% of actively managed equity investment companies have outperformed a relevant benchmark; we commend the UK smallcap, Japan, UK equity income, Emerging Market country funds and European subsectors, where more than three-quarters of companies outperformed”.
And what about the losers in this race for alpha? The analysts point the finger at global equities funds, sector specialists, global EM and global equity income.
In terms of individual fund level alpha, the analysts commend an elite who’ve produced consistently high information ratios over the last decade: these include “Mike Prentis, manager of BlackRock Smallers and Throgmorton takes the gold and silver medals, with bronze going to Finsbury Growth & Income. Over five years, Baillie Gifford Japan has the highest information ratio, with Mr. Prentis having to settle for silver and bronze.”
The chart below looks at the Information Ratio for the top performing fund managers – the second chart below that looks at those with the wooden spoon.