Some investments look identical but are anything but. Take funds and investment trusts run by the same manager and following the same investment strategy. Even though they look the same, performance can differ wildly. So why is this?
Both funds and trusts present opportunities and challenges for managers, with those that run both highlighting three key distinctions that investors need to be aware of, namely liquidity, boards and shareholder communication.
Liquidity
One of the core distinctions between trusts and funds is the approach to liquidity. Ken Wotton, managing director at Gresham House, explained that “open-ended funds must always hold enough cash or liquid assets to meet redemptions”, meaning they are less likely to be fully invested or to put investors’ cash into harder to trade assets.
Although it means investors can always sell their units (unless a fund is forced to shut its doors due to unprecedented withdrawals), it can limit managers and could force them to “sell assets at an inopportune time”. By contrast, shares in a trust are traded directly on the stock market rather than being redeemed from the fund, meaning managers have the freedom to hold more illiquid assets, he explained.
“That freedom allows us to take a genuinely long-term view and concentrate on highest conviction ideas without being constrained by daily flows,” he added.
For example, more than 70% of the portfolio in his Strategic Equity Capital Trust is weighted towards its top 10 holdings. By comparison, the Gresham House UK Smaller Companies fund has just a 35% weighting to its top 10.
Joe Bauernfreund, chief investment officer at Asset Value Investors added: “One of the key benefits of trust structure is the reassurance of permanent capital”.
This gives managers much more flexibility and freedom to pursue interesting opportunities, whereas “regulatory requirements around diversification mean we cannot hold positions with the same level of concentration in a fund".
Communication with shareholders
Easier communication with shareholders was also identified as a crucial advantage of the trust structure. Because investors in a trust are shareholders, it is much easier to promote “transparency and regular communication,” according to Bauernfreund. Trust investors are therefore usually better informed and more up to date than their counterparts holding the fund might be.
Shareholders can participate directly in trust management through annual general meetings (AGMs) and make their opinions more regularly known.
Simon Edelsten, manager of the Goshawk Global Fund and former manager of Artemis Global Select and Mid Wynd International Trust, agreed that this is an important benefit of trusts. “You know who your investors are, whereas in a fund it is difficult to know that and even more challenging to contact them,” he explained.
“The best approach to fund management is not just to perform. It is to justify your performance first and then perform off the back of it, and that is a lot easier in a trust.”
Sometimes, he explained, managers can be out of luck and it is difficult to tell when this might have occurred in a fund. In a trust, where managers know their shareholders and can explain the process, investors can ask if the strategy has contributed to the performance, making it easier to build a loyal base of investors.
"If you can get that communication right, I think trusts can definitely be easier to run", he concluded.
Boards of directors
Another differentiating factor between funds and trusts for these managers is the existence of an independent boards. Wotton explained that, in a trust, the board is generally made up of elected independent experts.
They add a layer of “governance and oversight” but because they are independent, they represent shareholder interests first and foremost. As a result, they serve as a way of “holding managers to account” and improve shareholder engagement.
“Well-run boards” are a great asset in helping the trust run more efficiently, with tools such as share buybacks helping mitigate challenges such as widening discounts, he added.
While managing trusts under board oversight could be challenging, Edelstein argued it was well worth it. He said: “If you have an investment trust with a very independent board that\ has good chemistry with the manager and the shareholders, it is tough to beat.”
For example, he explained that when managing Mid Wynd, he worked closely with the board and had a lot of trust from them. “Investors could see it, so we could trade at a premium. In trusts, you get to build this virtuous circle," he added.