At first sight, 2021 was a disappointing year for investment trust performance.
The Closed-End Investments index returned a very respectable 12.8%, but this was 5.5% behind the 18.3% return of the All-Share index. Meanwhile, the MSCI AC World index, boosted by the 28.1% return from the US, returned 20.1% in sterling.
This followed a 2020 in which the Closed-End index returned 17.8% – 27.6% ahead of the All-Share index, the largest gap in 30 years. This caused many UK institutional investors to complain about the inclusion of investment trusts in the All-Share index, arguing that it caused them to underperform, which was unfair.
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Yet in 2021, after that stellar 2020, investment trusts held the All-Share back. What happened?
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Why was 2021 a tougher year for investment trusts?
The average discount to net asset value (NAV) for investment trusts fell from 1.7% to 1.5% during 2021, so the underperformance cannot be explained by widening discounts. Indeed, a record £12.2bn of new capital was raised for existing trusts and a further £4bn for 15 new issues.
This, together with performance and after deducting some returns of capital, raised industry assets to an all-time high of £227.6bn, according to the Association of Investment Companies (AIC). Net capital raised of £14.9bn was, according to JP Morgan Cazenove, 247% higher than in 2020. This, alongside the low discount to NAV suggests no loss of investor confidence in the sector.
Although most of the equity component of the sector, especially the global funds, is growth orientated, this was not necessarily a problem. Though value shares, which had lagged badly in 2020, outperformed growth, the gap was narrow. The MSCI World Value index in sterling returned 23.9% and Growth 22.5%.
What held the sector back, according to JP Morgan Cazenove estimates, was primarily asset allocation, ie, too much exposure to lagging sectors. Stock selection, gearing (borrowing) and non-UK exposure all helped performance relative to the All-Share index.
The average return of trusts in the UK commercial property sector was 30.2% and seven funds in the broader property sector returned over 40%. Private equity, where value was abundant both in valuations and discounts, the return was 42%. The property and private equity sub-sectors account for £20bn and £27bn by value, over 20% of the total.
The performance of the growth trusts, however, lagged. Technology trusts (£7bn by value) returned 19% while the Dow Jones Technology index returned 30% in sterling and healthcare trusts (£6.4bn by value) returned a weighted average of -5.3% compared with a 21% sterling return from the MSCI World Healthcare Index. The poor performance of biotechnology shares, over-represented in the investment trust sub-sector, was a significant factor in this underperformance.
Growth-orientated generalist trusts also under-performed. The giant Scottish Mortgage Trust, valued at over £20bn, returned 10.5% – but it had more than doubled in 2020. Its performance in 2021 was way behind that of global indices. Sister trust Monks, with £3.3bn of assets, returned just 1%. Baillie Gifford’s other trusts also lagged badly, notably Edinburgh Worldwide (-21%), UK Growth (8%), European Growth (4%), US Growth (-5%) Japan (-10%) and Shin Nippon (-17%). Pacific Horizon (15%), though, had a surprisingly good year (more on that below).
Why did these and other growth managers perform poorly? Probably because they switched into up-and-coming growth stocks at the expense of what Ed Yardeni calls “the magnificent eight” at the top of the S&P 500, which continued to storm ahead. In 2022, though, it may be a different story.
Investment trust performance overall was also held back by the steady returns of much of the “alternatives” sector, which now accounts for approaching half of the total. While private equity and most property funds did well, the weighted average return in the renewable energy sector (valued at £15bn) was 8%. It was no higher in the rest of the infrastructure sector (valued at £17bn) with the honourable exception of 3i Infrastructure (+19%). Most debt funds also produced modest returns, in line with their targets.
How China hit returns in emerging markets
President Xi’s crackdown on the private sector caused a bear market in Chinese equities with the MSCI China index falling 20%. Whether the outlook for investment in China will worsen, stabilise or improve is probably the major uncertainty of the next few years. China, excluding Taiwan, accounts for 31% of the MSCI Emerging markets index and 37% of the Asia ex-Japan index (Hong Kong is regarded as a developed market so companies listed there are not included in emerging markets but are a further 7% of Asia ex-Japan). The drag of China resulted in small falls in both indices.
Despite this, some trusts in the sector performed remarkably well, notably those specialising in India, Vietnam and Frontier Markets. The three Asian smaller companies funds, whose benchmarks have much lower exposure to China, also did well. The scepticism towards Chinese companies of Mobius Investment Trust (+12%) and Pacific Assets (+15%) paid off but the 16% return of Baillie Gifford’s Pacific Horizon Trust was the most remarkable, as it followed a 133% return in 2021.
Also remarkable was the 35% return of RIT which sets out to lag on the upside in order to protect on the downside. Caledonia (+44%) did even better. Both benefited from the success of their private equity investments. Among the global trusts, strong investment performance, but no private equity, resulted in AVI Global, Mid-Wynd and Brunner returning over 20% while nearly all small cap trusts in all markets except Japan performed well.
Many of the UK funds beat the All-Share index with Merchants (+32%) and Fidelity Special Values (+27%) in the lead. The same was true in Europe where BlackRock Greater Europe (+32%) led the pack and the 6% appreciation of sterling against the euro did not appear to hold returns back.
Overall, there were plenty of triumphs, some disappointments but very few disasters. Good fund managers do not churn their portfolios or make radical changes to their investment styles so it is not surprising that some of the heroes of 2020 had a disappointing year. In contrast, most of those that struggled in 2020 were rewarded in 2021 by better market conditions for their specialities and styles.
The bears believe that persistent inflation and rising interest rates will make 2022 a difficult year; the bulls that economic growth will support the uptrend in corporate earnings and that a return to normality in monetary policy is healthy. Whoever is right, investment returns, both for growth (but not at any price) and for value investors, are likely to be healthy over the next five years, which should be the horizon of most investors.
