Catataxic funds outperform

Recent research from Collins Stewart, a UK stockbroker, shows that investment trusts have comprehensively outperformed open ended funds over the last 10 years. These funds are rarely recommended by financial advisers since they don’t pay commissions (i.e. kickbacks) to the IFA’s who promote them. In major markets, Investment Trusts gave investors a 106% return while unit trusts only returned 36%. In emerging markets, the difference was even greater: 357% vs 230%.

OK. So maybe the last time someone tried to explain the difference between an Investment Trust and a Unit Trust to you, you edged away and went to find the fun guys at  the party. Maybe you would even prefer to be stuck on a long distance flight in the seat next to an overenthusiastic proctologist, than listen to an explanation like that. But here goes anyway, because there is a catataxic twist to the story.

An Investment Trust is a form of collective investment that has been around a long time (since 1868). It is a closed end fund constituted as a public limited company. So unlike a normal unit trust, once the money has been raised no new money comes into the fund ( that’s why it is called “closed end”). Investors buy and sell shares in the company which can trade at a premium or discount (more likely) to the underlying asset value.

For an open ended fund, like a unit trust, OEIC or mutual fund, investors money can flow in and out. When it is performing well, new money floods in. When it is performing badly, investors pull their money out forcing the fund to sell its holdings which further reduces prices and potentially creates a downward spiral. It is this ‘forced selling‘ effect which may explain the difference in performance. The manager of an investment trust can afford to be more long term in outlook. The money he manages is locked up in the trust and can’t be withdrawn. He only has to worry about stock market performance, not about investors pulling their money out. He is therefore less likely to panic, and more likely to outperform in turbulent markets.

In catataxic terms, an investment trust is a level two entity, hermetically sealed off from level 1. In contrast, a unit trust has a permeable membrane between the two levels so is not truly a level 2 entity. An investment trust is a catataxic fund, a unit trust is not. The research proves that the key to outperformance is catataxis.

Leave a Reply