Why closed-ended funds are winning the RDR race

Investment trusts have an inbuilt advantage over of their open-ended peers in the run up to RDR, writes F&C's Ed Morse.

In spite of their enduring popularity with private investors and discretionary wealth managers alike, investment trusts have historically been largely ignored by independent financial advisers. With implementation of the Retail Distribution Review fast approaching, however, advisers should not be asking ‘why investment trusts?’ so much as ‘why not?’.

As readers will be only too aware, from the start of 2013 advisers who wish to call themselves ‘independent’ will have a duty to consider the whole investment marketplace when choosing solutions for their clients. This means not just the open-ended funds that feature so prominently on platforms at present, but also structured products, exchange-traded funds and investment trusts.

‘RDR ready’

Investment trusts arguably have an inbuilt advantage ahead of the new regime, as while open-ended funds wrestle with the headache of how to unbundle their charges and offer ‘factory gate’ pricing, their closed-ended counterparts are already ‘RDR ready’.

With more and more advisers expected to move to a fee-based model, products with low and transparent costs should gain favour as customers seek to keep a lid on extra expenses. Investment trusts can be bought with only the 0.5% government stamp duty to pay, rather than the upfront fees (often including an element of RDR-unfriendly commission) levied by most open-ended funds. In addition, research by the AIC shows annual expenses on two-thirds of investment trusts are below the open-ended ‘industry standard’ of 1.5%, with a third of trusts having TERs below 1%.

Low costs

These charges are comparable with those of some index-tracking investments, but can give investors access to the benefits of active management and diversification. Recent research by F&C shows the potential dangers of tracking an index such as the FTSE 100, a third of whose value is now tied up in oil and mining stocks, with a further 20% in financials.

Many of the lowest-cost investment companies, with TERs of around 0.5%, offer access to a global spread of companies in a wide range of sectors, making them a useful ‘core’ holding in a portfolio.

Better performance record

In addition, as a 10-year study by investment trust experts Winterfloods showed last year, closed-ended funds have actually tended to outperform their open-ended rivals. In seven of eight major areas (global growth, UK income growth, UK smaller companies, Europe, US, Far East ex Japan and emerging markets), closed-ended funds outperformed over one, five and 10 years to the end of September 2010, with Japan the only area where open-ended funds did better.

This is based on past performance, of course, and there have been times when open-ended funds will have done better, but it is certainly not an argument for dismissing investment trusts out of hand.