Many private investors making a choice of what to add to their ISA portfolio might be musing over investment trusts and exchange-traded funds.
Both trade on the stock exchange - but which is better?
As any fan of Harry Hill across the ages would obviously respond, there's only one way to find out: FIGHT!
Before looking at performance tables it was difficult to compare the long-term performance of the likes of F&C Investment Trust (LSE:FCIT) PLC, launched in 1868, JPMorgan American Investment Trust, birthed 140 years ago, or Scottish Mortgage Investment Trust PLC (LSE:SMT), founded in 1909 have no real parallel.
ETF or IT or WTF?
But ETFs have bigger numbers in another sense, with last year another record-breaker for this sub-sector, with over US$10trn now in assets under management (over US$7trn of that in the USA), according to the latest Brown Brothers Harriman survey.
ETFs, exchange-traded commodities (ETCs) and other exchange-traded products (ETPs) attracted more than US$1trn of new assets during the year, helped by the launch of just over 1,500 ETPs, including the first Bitcoin futures ETFs, the first activist ETF and even an ETF that seeks to track the performance of the most talked-about stocks on social media.
In London, there are more than 1,000 ETFs listed on the main market, while in comparison there are a little over 400 investment trusts.
So, after finding out last week that investment trusts are perhaps the key tool in the box for a large proportion of ISA millionaires, at least it makes it a bit easier to choose between these various closed-ended funds.
Our performance tables did not include US ETFs, mainly as they are not available to most UK investors, though in the last few years have been making headlines – especially Cathie Wood’s ARK Innovation ETF. At its February 2021 it was peak was up around 666% since launch in 2014 (but down 57% since).
Best performing funds
But below as you can see from the tables of the best performing ETFs and trusts of the past five years and 10 years, the very top ETFs have outperformed the best investment trusts.
However, excluding one ETF that is focused on the price of a single platinum group metal, rhodium, much in demand in the auto sector, and the next few all being leveraged funds (where rises and falls are magnified), the top performers are not that different.
Top investment trusts over 5 years
31/03/2017-30/03/2022
Return %
Investment trust
1 · Triple Point VCT C · 344.7
2 · Edge Performance VCT 'H' · 247.8
3 · Allianz Technology Trust · 226.8
4 · HgCapital Trust (LSE:HGT) · 203.2
5 · Scottish Mortgage · 197.8
6 · Adams · 190.7
7 · Polar Capital Technology · 176.5
8 · 3i · 173.4
9 · Pacific Horizon · 170
10 · BlackRock World Mining Trust · 141.7
Top ETFs over 5 years
Exchange-traded product (leveraged in italics) · 31/03/2017-30/03/2022 · Return %
1 · db Physical Rodium ETC · 1629.4
2 · WisdomTree NASDAQ 100 3x Daill Levereged ETP · 757.4
3 · WisdomTree S&P 500 3x Dly Lvrgd ETP · 279.1
4 · WisdomTree Palladium 2x Dly Lvrgd ETP · 251.4
5 · iShares S&P 500 Information Tech Sector ETF · 206.9
6 · Xtrackers S&P 500 2x Levergd Daily Swap ETF · 206.7
7 · SPDR S&P US Technology Select Sect ETF · 200.6
8 · Invesco Technology S&P US Select Sector ETF · 196.6
9 · WisdomTree Nickel ETC · 189.7
10 · Xtrackers MSCI World Information Technology ETF · 183.9
“Often ETFs are very specific, and there are a lot of them, so those aimed at specific areas can do very well, albeit with a lot of volatility,” says Peter Sleep, senior portfolio manager at 7 Investment Management.
The simplicity of passive funds, along with their low, low costs – were the main points of appeal for investors.
This means an index-tracking ETF will never outperform the return of the index it is tracking – but a big change in the last couple of years has been the rise of thematic ETFs, which have allowed investors to choose a specific sector to track, from agriculture and commodities, to cannabis-focused companies, cloud internet companies and space companies.
Drilling down even more specifically, the ability to track individual commodities such as rhodium, nickel or wheat, means while you might get it right/lucky and have picked rhodium as the metal to track 10 years ago, but if the other hand if you had gone long on oil in late 2019 you would have been wiped out in early 2020 when oil futures went negative.
Looking at our performance tables, the best performing investment trusts and ETFs have broadly been driven by the same themes in the last decade namely technology and growth stocks, says Laith Khalaf, head of investment analysis at AJ Bell.
Hence, Invesco Technology S&P US Select Sector is in the top five over 10 years, followed by Xtrackers MSCI World Information Technology, SPDR MSCI World Technology and Lyxor MSCI World Information Technology.
Top investment trust over 10 years
Investment trust · 31/3/2012-30/3/2022 · Return %
1 · Allianz Technology Trust · 754.8
2 · Scottish Mortgage · 625.8
3 · 3i PLC · 598.1
4 · Polar Capital Technology · 540.7
5 · Lindsell Train · 497.9
6 · VietNam Holding · 454.5
7 · Oryx International Growth · 432.0
8 · HgCapital Trust (LSE:HGT) · 420.9
9 · EPE Special Opportunities · 403.5
10 · Baillie Gifford Shin Nippon · 380.7
Top ETFs over 10 years
Exchange-traded product (leveraged in italics) · 31/3/2012-30/3/2022 · Return %
1 · db Physical Rhodium ETC · 1,422.7
2 · Xtrackers S&P 500 2x Leveraged Daily Swap ET · 1,037.4
3 · Invesco Technology S&P US Sel Sec ETF · 612.8
4 · Xtrackers MSCI Wld Info Tech ETF 1C · 562.0
5 · SPDR MSCI World Technology ETF USD Acc · 559.4
6 · Lyxor MSCI World Info Tech TR ETF · 552.8
7 · Invesco Consumer Discretionary S&P US Select Sector ETF · 446.5
8 · Invesco Health Care S&P US Select Sector ETF · 404.0
9 · Lyxor S&P 500 ETF · 372.6
10 · Xtrackers S&P 500 Swap ETF · 371.8
Costs are not the only issue
However, with the added complexity of thematic ETFs comes additional cost too, as Khalaf observes.
“While plain vanilla ETFs are cheap as chips, if you want a more specialist investment you are likely to have to pay a premium, possibly more than some actively managed investment trusts.”
As with purely active investment trusts, where Khalaf says investors “need to make sure they are comfortable with the investment philosophy of any trust they are investing in, and have inspected the track record of the manager too”, with thematic ETFs investors need to check what companies are or aren’t being tracked and “requires as much due diligence as investing in active funds”.
For example, comparing two ETFs focused on the shift to electric vehicles and you find their total expense ratios a slightly different at 0.4% and 0.45% but otherwise are very different: the iShares Electric Vehicles and Driving Technology UCITS ETF holds Tesla and Nvidia with 4% as its top weights, with Ford and Toyota in the top 10; while the SPDR S&P Kensho Smart Mobility ETF has no sign of Tesla in its top 10, which includes Uber and China’s Li Auto and is topped by transmission maker Allison.
Likewise in investment trusts, which in a way pioneered thematic investing, where London has three closed-ended funds focused on solar power, for example, all of which are predominantly focused on the UK market, but with plenty of subtle differences not only in the size of their portfolio and their premiums to net asset value.
Flexibility first?
Investment trusts can be a lot more flexible compared to ETFs, in what they can hold, says Sleep, such as those that invest in unlisted investments, start-up companies or private equity.
“This can be very profitable as Scottish Mortgage has shown,” Sleep adds, noting that by comparison, ETFs are UCITS funds and can only hold transferable securities, the ‘TS’ of UCITS, “so they cannot hold unlisted companies, property, ships, airplane leases, windmills and so on”.
The closed-ended structure of investment trusts also means managers can take a genuinely long view of their investments, as they are under no pressure to sell when people sell their shares, says Nick Britton, head of intermediary communications at the AIC, the investment trust’s industry body.
Trends in the investment trust world mean a lot of newer closed-ended funds aim to offer investors income rather than capital gains, with several flotations of trusts aimed at achieving high levels of income from green infrastructure assets like the aforementioned solar trio and wind power peers, as well as other illiquid assets like social housing, asset-backed credit and music royalty rights.
And there are other themed investment trusts aiming more for capital growth, with one focused on hydrogen projects, one on space technology
“Investment trusts have other bells and whistles that investors can use to their advantage,” says Kyle Caldwell, funds specialist at Interactive Investor.
These include the ability to hold back 15% of income generated each year, which is why investment trusts are more consistent than funds at maintaining or increasing income payments. Investment trusts also have the ability to gear, which can turbocharge returns in a rising market. However, in a falling market a geared trust will lead to greater losses.”
Over a term of at least five years, because of this gearing, investment trusts are generally expected to outperform.
All this could be why ISA millionaires hold them, suggests Sleep.
But by the nature of their permanent capital and closed-ended structure, the shares of investment trusts can trade at a premium discount to their underlying holdings, while an ETF’s market price is adheres more precisely to its underlying assets, which are either physically owned by the ETF or by ‘syntheticaly’ replicated with the help of a deep-pocketed investment bank (see ETFs with Swap in their name).
An example of a trust at a big discount is value investor Pershing Square Holdings (LSE:PSH) Ltd, where the discount is above 30%, and there are several others currently in the teens.
READ: UK small and mid-cap trusts move to wide discounts after market sell-off
“It can be very difficult to close this discount although in fairness to Pershing Square, they have been buying back stock to try to close the discount,” says Sleep. “This is in contrast to other managers.”
Some investment trusts, such as Capital Gearing Trust, do operate a zero discount mechanism to try and eliminate this, while others employ similar measures, such as the buyback recently announced by Honeycomb.
Balance is key for investors
For many investors having a mixture of active and passive funds is probably the most sensible approach.
“One way to structure a portfolio is the core and satellite strategy," says Caldwell. “The core of the portfolio should be investments that provide few surprises – such a global or developed market funds – either actively or passively managed.
“The satellite holdings are spicier - higher-risk funds in the hope of generating higher growth. Depending on your risk appetite, options include diversified active funds that invest in an adventurous manner – such as smaller companies and those investing in the emerging markets region.”
He suggests other adventurous funds could specialise in a certain sector or theme, and could therefore be ETFs or themed investment trusts.
Sleep also believes the core building blocks of a diversified portfolio are broad index trackers following the likes of the FTSE 100, the S&P 500 and the main bond ETFs.
Hector O’Neill, boss of HanEtf, suggests there should be “room in a portfolio for high conviction themes which should bring opportunities for outperformance versus plain beta”, as well as their low cost.
Aside from their strong total return performance, investment trusts also have useful income advantages, such as the ability to smooth dividends by reserving income in good years to pay out in bad ones, points out Britton.
“As a result, many have unparalleled track records of increasing annual payouts to shareholders,” he says, as backed up by the AIC’s ‘dividend heroes’ list of trusts that have grown their shareholder payouts for not just years but for decades.
Low fees versus performance
To finish it's worth noting that the standard disclaimer that 'past performance is not a guarantee of future results' has been refuted by research, with a new disclaimer proposed by Dr Philip Newall from CQ University in Australia: "Some people invest based on past performance, but funds with low fees have the highest future results."
But there's also plenty of research that supports the case for a more concentrated but still highly diversified approach, as investment trusts can offer, such as a 2013 paper by finance professor turned fund manager Antti Petajisto finding the most active stock-pickers outperformed their benchmarks by 1.26% a year after fees.
“The overwhelming evidence is that fund managers who are willing to back their convictions with punchy bets are the ones who tend to outperform by the highest margin,” Kepler investment trust analyst William Sobczak said in a debate over this same fight elsewhere.
“These findings are particularly pertinent for investment trusts where the closed-end structure allows managers to hold more concentrated portfolios and take a longer-term view on them,” said Sobczak.
Best performing investment trusts over 20 years
Investment trust · 31/3/2002-30/03/2022 Return %
1 · HgCapital Trust (LSE:HGT) · 1,722.7
2 · Scottish Mortgage · 1,524.9
3 · Aberdeen Standard Asia Focus · 1,506.2
4 · Lindsell Train · 1,387.5
5 · Pacific Horizon · 1,246.7
6 · Polar Capital Technology · 1,216.8
7 · JPMorgan Indian · 1,104.6
8 · BlackRock Smaller Companies · 1,087.3
9 · JPMorgan European Discovery · 1,034.2
10 · Rights & Issues Investment Trust · 1,032.7
11 · Scottish Oriental Smaller Cos · 999.5
12 · TR Property · 993.5
13 · The European Smaller Companies Trust PLC · 969.0
14 · European Opportunities Trust · 968.7
15 · Allianz Technology Trust · 963.7
16 · Oryx International Growth · 933.3
17 · BlackRock Throgmorton Trust · 910.4
18 · Standard Life Private Equity · 886.6
19 · JPMorgan UK Smaller Companies · 874.1
20 · JPMorgan Emerging Markets · 853.8
Table data from Morningstar/AJ Bell/AIC