How to invest amid crumbling post-war certainties

“Passive outperforms active. This has become a widely accepted truth, supported by regulators, by many advisers and, increasingly, by private investors. The logic is seductive: The argument is that investment is always a zero-sum game. In every trade, someone wins and someone loses. Therefore, on average, passive will always outperform because the fees are lower.

“This is correct in theory, but it doesn’t appear to hold true for investment trusts in practice. Investment trusts are a good representative for active management because they have a fixed pool of capital. The manager does not have to manage inflows and outflows, so therefore performance could be said to be a purer expression of their skill and judgment. 

“The report took ETFs as a proxy for passive investment and compared the two. The research compared ETFs and investment trusts within comparable Morningstar sectors. 

“At the top level (the Global Broad category), investment trusts outperformed overall in all four of the categories reviewed – equity, allocation, fixed income and miscellaneous. They also outperformed in triple the number of instances – 11 compared to four – so it was not just a few great funds influencing the results. 

At the sector level, investment trust outperformance also held true. They outperformed 53 per cent of the time against ETFs over one year, 76 per cent over three and five years, and 90 per cent over 10 years. The research isolated 19 sub-categories: Over 10 years, closed-ended funds outperformed in all categories except one: US Equity Large Cap Blend.”


What makes investment trusts different?

The fundamental difference is that they are constituted under company law; unit trusts, open-ended investment companies (Oeics) and ETFs are creatures of trust or other specific laws.

The beauty of company legislation is that it gives responsibility to boards of directors, as well as to investment managers, by creating a hierarchical structure. This clarifies responsibility and ensures good communications. 

Boards lay down strategies and managers execute that strategy through their agreed tactical investment plans. Both sides can ‘do nothing’ when markets make it clear that nothing is to be done. This is more often the case than investors imagine.

Company law enables profits from good years to be held back for when times turn bad, so prudent investment trusts can maintain dividend income through the years. Certain members of the Association of Investment Companies have held or increased their dividends for 50 or more years. 

It is this compounding of small annual sums that produces large fortunes and justifies equity investment.

This is why using Isas to hold cash or invest in fixed interest securities is wasteful. Fees are paid for tax advantages that only accrue through rising dividends, and investment trusts are the best source of those.