Over the next few years, interest rates are expected to gradually move higher, but savers should not bank on savings rates becoming more generous overnight. Instead, look no further than investment trusts to trounce inflation over the long term
The minimum aim of every investor should be to ensure the returns they receive from their investments are above and beyond the rate of inflation. On this front, investment trusts more than hold their own, research by Money Observer (Moneywise’s sister magazine) has found.
Researchers looked at annualised returns for investment trusts over the past 20 years and pitted them against inflation in the shape of the retail prices index (RPI), which over the period has risen by an average 2.5% each year. The RPI rate of inflation has not been considered a national statistic since 2013; it is higher than the consumer price index (CPI), which has run at 1.8% annualised since October 1998, principally because it includes mortgage interest payments.
Despite the misgivings of the Office for National Statistics that RPI is “flawed” due to its methodology, it is still widely used and influences rail fares, student loan repayments and ‘gold-plated’ final salary pension schemes. Moreover, the UK government uses it as a reference point for the index-linked bonds it issues.
After crunching the numbers, researchers found the vast majority of investment trusts with a 20-year track record comfortably beat the RPI inflation measure. Focusing on key sectors – multi-asset trusts, UK growth trusts, UK income trusts and global growth and income trusts – all the trusts achieved annualised share price total returns that outstripped RPI. When reinvested dividends were eliminated, 15 of the 59 trusts in the various sectors shown in the table (see below) failed to beat RPI over the period – but the success rate of 75% is still high.
Open-ended funds also put in a good showing against RPI, with the number of outperformers highlighted in the table below by sector. The only fund to underperform RPI on a total return basis was Janus Henderson Multi-Manager Diversified, but it had an annualised return of 2.4% so it only fell short by 0.1%.
Best Performing Investment Trusts Over the Past 20 Years
|Investment trust||Fund type||Annualised returns (share price raw return without income reinvested) (%)||Annualised returns (share price total return with income reinvested) (%)|
|1st place||Multi-asset||RIT Capital Partners: 9.4||RIT Capital Partners: 10.6|
|2nd place||Multi-asset||Capital Gearing: 8.1||Hansa Trust: 9.8|
|3rd place||Multi-asset||Hansa Trust: 7.9||Capital Gearing: 8.8|
|1st place||UK growth||Fidelity Special Values: 12.4||Fidelity Special Values: 14|
|2nd place||UK growth||Mercantile: 9.2||Mercantile: 12.6|
|3rd place||UK growth||Schroder Mid Cap: 8.7||Schroder Mid Cap: 10.4|
|1st place||UK income||Finsbury Growth & Income*: 7.4||Lowland: 10.8|
|2nd place||UK income||Lowland: 7.3||Finsbury Growth & Income: 10.4|
|3rd place||UK income||Perpetual Income & Growth: 4.6||Perpetual Income & Growth: 8.5|
|1st place||Global growth||BMO Global Smaller Companies*: 11.1||BMO Global Smaller Companies: 12.6|
|2nd place||Global growth||British Empire: 10.5||British Empire and Scottish Mortgage: 12.2|
|3rd place||Global growth||Scottish Mortgage*: 10.4||Mid Wynd International: 10.9|
|1st place||Global income||JPMorgan Global Growth & Income: 7.2||JPMorgan Global Growth & Income: 9|
|2nd place||Global income||Murray International*: 4.8||Murray International: 8.9|
|3rd place||Global income||Scottish American: 3||Scottish American: 6.9|
*A member of Moneywise First 50 Funds for beginners. Source: AIC, as at 30 November 2018
Bumpy ride for equities
The past decade has been a relatively comfortable backdrop for investors; with this in mind, the research covered a 20-year period as it encompasses the full extent of the global financial crisis and also the spectacular tech boom and bust in the early 1990s. Therefore, it has not been a smooth ride for equities.
Nonetheless, while average inflation has been relatively benign over that period, the high number of investment trusts and funds that have beaten RPI provides strong evidence that the best way to keep ahead of inflation in real terms is by investing in risk assets, principally equities.
“The ultimate first aim for any investor is to stay ahead of the cost of living,” says Ben Willis, head of portfolio management at Chase de Vere.
“But if you are not invested and are instead leaving investable assets in a bank or building society, this growth is difficult to generate: the days of savings rates offering 5% or 6% on deposit, which they did prior to the financial crisis, are long gone.”
Indeed, beating inflation has become much harder in recent years as savings accounts linked to inflation have been disappearing, with no such product available at the time of writing.
Interest rates to rise
Moreover, the decade-long era of loose monetary policy has drawn to a close; barring a Brexit-led economic meltdown, interest rates are expected to rise in the coming years, which in theory will lead savings rates gradually higher. Increases, though, are unlikely to be notable, as the big banks are less competitive than they used to be on this front.
In any case, Adrian Lowcock, head of investment at Willis Owen, points out that rates are likely to remain below the Bank of England’s 2% inflation target for the foreseeable future.
“I cannot envisage the day when interest rates will ‘normalise’; it will be a long and steady process that takes several years, as both households and businesses have got used to interest rates being as low as they currently are.”
Therefore, Mr Lowcock says, in the next 10 to 20 years the stock market will remain the best route to beat inflation. But Mr Willis anticipates trickier times ahead, particularly for retirees who are using their investments to help fund their lifestyle. Those in this boat should focus on income-generating investments and look to take the natural yield being produced by the portfolio.
He says: “After such a strong decade for equities, I expect the direction of travel from A to B will be bumpier over the next decade, but those who invest for the long term will still do much better than two of the other main alternatives to protect against inflation: cash or bonds.”
Overall, as the table above shows, for investment trusts the top performer out of the sectors examined was Fidelity Special Values, producing an annualised total return of 14%. Seven other trusts have produced annualised returns of 10%-plus on a total return basis over the past 20 years: BMO Global Smaller Companies, British Empire, Scottish Mortgage, Mercantile, Mid Wynd International, Lowland and RIT Capital Partners.
Another key takeaway is the power of dividend reinvestment. For the AIC UK equity income sector as a whole, the average return over the period if dividends are not reinvested stands at 2.5% – the same as RPI. But on a total return basis, with the compounded growth of reinvested dividends added into the mix, the sector average return leaps to 6.9%. In some cases, this phenomenon can almost double an investor’s return, with Perpetual Income & Growth a case in point, returning 4.6% annualised without dividends but 8.5% in terms of total returns.
China and India out ahead
On the whole, global trusts put in a stronger showing than UK-focused trusts. The global sector average was 8.9% annualised on a total return basis, versus 5.4% for UK all companies.
Overall, looking across all Association of Investment Companies (AIC) sectors, the standout performer over the period was Asia Pacific. This sector mainly includes trusts that invest in either China or India. The average trust’s annualised total return stood at 13.8%. The worst-performing equity sector was UK Equity Income.
But as Mr Lowcock points out, as things stand today, with the FTSE 100 offering a yield of almost 5%, UK equity income investment trusts and funds are perhaps the most interesting buying opportunity in town.
He adds: “The UK is arguably the most unloved stock market at the moment. But it is at times like these, when it feels uncomfortable to invest, that attractive opportunities can present themselves to patient, long-term investors.”
TRUSTS THAT KEEP INFLATION AT BAY
Some investment trusts explicitly target inflation as a benchmark for their performance, with the standout example being RIT Capital Partners, chaired by Lord Rothschild. The trust’s formal aim is to beat the RPI measure by 3% a year. The cautiously managed trust has easily achieved this feat over the 20-year period, producing an annualised total return of 10.6%.
In addition, other investment trusts aim to grow their dividends at a faster rate than inflation, two examples being Bankers and Scottish American Investment Company. Both trusts are ‘dividend heroes’, having raised payouts every year for 51 years and 38 years respectively.
Furthermore, real assets such as infrastructure and property have historically acted as impressive long-term hedges against inflation. Infrastructure offers investors exposure to high-quality inflation-linked cashflows. In Money Observer’s January 2019 wealth creation guide, The Renewables Infrastructure Group was tipped.
This trust invests for a high and consistent income stream in wind, solar and battery storage projects.
Tim Cockerill, investment director at wealth management firm Rowan Dartington, likes it because managers InfraRed Capital Partners are very experienced.
“It works well as a diversifier in a portfolio, with the majority of the return coming from income,” he says.
For property, TR Property was favoured.
Sandy Cross, investment manager at Rossie House Investment Management, picked the trust as his preferred choice.
He adds: “The manager is highly regarded; the trust is a good option for those wishing to hold property.”
This feature first appeared in Moneywise’s sister publication, Money Observer.