Pricey funds may pay off over time

INVESTORS are often told that minimising costs should be a priority. However, there are certain instances where paying a little bit extra can reap rewards.

This may be the case when it comes to choosing between open-end funds and close-end funds. Recent research from Winterflood has shown that, over the long term, closed-end funds (despite often being more costly overall) have outperformed their open-end equivalent.

Each type invests in similar assets: stocks, bonds and property, both domestically and internationally. However, close-end funds tend to be more actively managed, meaning that a fund manager specifically chooses certain holdings, believing that they will outperform the market.

There are thousands of open-end funds in the UK, and some are also actively managed. But Jason Whitcombe of Evolve Financial Planning says that there has been a suspicion that some merely mimic their benchmark index, rather than actively trying to outperform it. For Whitcombe, at least, this is because the failure by an open-end fund manager to at least match his or her index is akin to “professional suicide”.

At a glance, both open and closed-end investments look similar. They can be purchased from fund platforms, like those offered by Hargreaves Lansdown or Bestinvest. Both can be held in an individual savings account (Isa) wrapper, or a self-invested personal pension (Sipp). The key difference lies in their different legal and charging structures.

The two main types of open-end funds are open-ended investment companies (OEICs), in which you buy shares, and unit trusts, in which you buy units. A closed-end fund (like an investment trust), on the other hand is a public company, listed on the stock exchange.

The charging structures are where these differences begin to matter. Open-end funds typically charge upfront fees of around 5 per cent of assets under management (AUM), although some brokers offer discounts. They also charge annual management fees of about 1.5 per cent of AUM. Closed-end funds, on the other hand, are listed shares. Consequently, you incur dealing fees (around £10 per transaction) and stamp duty. This mostly means they are more expensive.

However, where the value of an open-end funds is derived from its underlying net asset value, closed-end funds can trade at a premium (or a discount), based on the demand and performance of the fund.

Winterflood’s research shows, in the last quarter, closed-end funds outperformed their open-end equivalent in 14 out of the 15 subsectors. And, over a 10-year period, they outperformed in 13 out of the 15 subsectors (see chart below for relative outperformance).

Danny Cox of Hargreaves Lansdown says that one reason is that they are able to use leverage, which can amplify returns over time. He points to Standard Life’s small cap fund, and Aberdeen’s Asian fund as good examples of well-run investment trusts.

But is this a price worth paying? While closed-end funds have outperformed, they tend not to be as liquid as open-end funds, particularly for smaller investment trusts. At times, this can make it tricky to sell your holdings.

Witcombe says the choice should come down to your sophistication as an investor. “Anyone seeking an actively-managed fund should look at investment trusts,” he says. They may be more suited to investors that are confident about picking specific funds. Those looking for passively-managed investments – for example trackers that match the performance of an underlying index – may be suited to open-end funds.

Despite the extra fees associated with investment trusts, their performance makes them worthy of consideration. Sometimes, it is worth paying extra.