Why investment trusts are winning the low-cost war

F&C Investments’ Mike Woodward explains how investment trusts have the edge over open-ended funds and ETFs in the low-cost battle.

Recent weeks have seen the raising of annual management fees on certain open-ended funds by a number of leading fund providers.

While it would probably not be economic for those already invested in these funds to sell them on the basis of these increased fees as they would probably incur costs of more than they would save by selling and reinvesting elsewhere it may make new investors think twice about where they put their money.

Investment trusts have long had a cost advantage over open-ended funds, with no upfront charges other than stamp duty on purchases, and annual management charges that tend to be lower than the industry-standard 1.5% AMC on actively managed open-ended funds.

Research published by the Association of Investment Companies in May showed two-thirds of its member companies had a TER (which includes the AMC as well as other costs) below 1.5%, with almost a third being under 1%.

The impending implementation of the Retail Distribution Review has thrown investment costs into the spotlight, as the fees on open-ended funds often include an element of initial or ongoing commission for the financial adviser, which will be outlawed under the new regime.

Investment trusts, while popular with wealth managers and individual private investors, have been under-represented in the IFA market, perhaps because they pay no commission, but this could change when the RDR comes into force at the start of 2013.

Upfront costs

With customers faced with paying upfront for advice rather than simply losing some of their returns in the less tangible form of commission, fund charges will become more of a factor in investment choice.

It is likely that OEIC and investment trust charges will see some convergence over the next 18 months  indeed, JPMorgan and Schroders have both launched low-cost ‘index plus’ quasi-active funds with base annual fees of 0.4% in recent months.

Conversely, average investment trust TERs have crept up in recent years.
Average figures can be misleading, of course, and the main driver behind rising investment trust TERs is the nature of recent launches.

While diversified funds investing in traditional asset classes remain the cornerstone of the investment trust sector, launches in the past few years have been focused in more specialist areas many are domiciled in the Channel Islands and invest in areas such as private equity, property and hedge funds, all of which are more expensive to access than, say, a portfolio of blue-chip shares.

Looking at the AIC’s figures on investment company charges, while the average investment company TER is 1.7% broadly comparable with the average TER on open-ended funds in the Global Growth sector, home to such venerable names as Foreign & Colonial Investment Trust, 57% of trusts have TERs below 1%.