Beating the market...

...these days, It ain't easy as David Bowie once sang. Any way I digress but since the large majority of active fund manager tend to under perform the index in the medium term -  this has led to the increasing popularity of low cost index funds and in some cases so called smart beta funds.

However as Status Quo sang - Is There a Better Way?

I believe Investment Trusts or IT's as they are sometimes known, can be a better way to get a diversified exposure to all kinds of markets. To summarise I believe their main advantages of IT's are as follows:

1. A fixed capital base which should mean the manager(s) can take a longer term view without having to worry about redemptions. This often helps performance as open ended funds managed by the same manager often underperform their IT equivalent.
   
2. An independent board of directors to oversee the fund and act in shareholders' interests if things go wrong.
3. The ability to gear, which should be helpful for equity funds as markets tend to rise around 60% of the time, but can also detract from performance in more difficult market conditions. So you will want to know by whom, how and within what parameters this is managed and monitored.
4. The possibility to buy assets at a discount, which can then either narrow or widen to add or detract from the underlying NAV return.
5. Low charges - this generally used to be the case, although since the Retail Distribution review this is not now necessarily always the case and so not such an advantage now.
   

Now while it might have seemed easy for me to out perform the All Share Index by nearly 8% per annum over the last 6 years, believe me it take a lot of commitment, time and dedication to produce those kind of results. Now obviously that is what fund mangers are paid to do, but often they fail due to hugging the index too much and suffering from high charges attached to their open ended funds.

Well I have suggested that carefully selected IT's can be a better way of beating the market. What's the evidence for this? For example you could have achieved a similar level of outperformance to me over the last 5 years with just three trades, yes three purchases to be precise.

As the Eagles sang I call it my Take it easy FTSE All Share Beater Portfolio, which is simply constructed as follows:

60% Merchants Trust - MRCH - FTSE Benchmarked High Yielding Trust which has increased its dividend for the last 33 years. You can watch an interview with the Manager Simon Gergel at the trusts site. This is a fairly unique trust as I'm not aware of too many others which benchmark themselves against the FTSE 100 and offer a yield of close to 5%. As a result it has tended to trade close to or at a small premium to its Net Asset Value (NAV) in recent years. However it is worth noting that this one is quite highly geared at 18%.

30% JP Morgan Mid Cap - JMF - since 2012 it has been managed by run by Georgina Brittan who is doing a good job on improving the performance on this one, but despite this it trades on a 15% discount. You can read more about it and see video commentaries from Georgina at the trusts site. Alternatives there would be the larger and cheaper Mercantile Trust (MRC) run for years by JPM & Martin Hudson, although this one has lagged rather badly in the last 3 to 5 years. A much better and closer alternative in terms of size, cost and performance would be the Schroder UK Mid Cap Trust (SRC) run by the highly regarded Andy Brough and Rosemary Banyard.

10% Henderson Smaller Companies - HSL run by Neil Hermon since 2002, is one of the cheapest small cap. investment trusts (0.5%) and has seen a much improved performance in the last 5 years or so to make it one of the best performers in its sector. Despite this, in common with most small cap funds it also trades on a discount of around 15%. You can read all about it and see another video with another manger at this trusts site. Well regarded alternatives in this sector are from Black Rock (BRSC) and Standard Life (SLS) although the latter has also gone off the boil a bit in the last few years.

If you had bought these three trusts five years ago it would have theoretically delivered a Net Asset Value return of 95.8% compared to 47.9% total return from the All Share for a 47.9% outperformance or 8.14% per annum (Source: JPM & Compound Income.org calculations). This is about the same level of performance I have achieved but it would have been a lot less effort this way! See the chart below to see how each of them performed versus the index over the last 5 years. So if you are a busy person struggling to find the time to run your own portfolio then you could consider Investment trusts as an alternative for the reasons given above.

The rationale for the weights was to provide a broadly based UK portfolio but with a tilt towards Mid and Small Caps. which have tended to outperform over time in the past. Of course the key phrase here is in the past, as all the marketing material always says the past is not a guide to the future. Looking to the future I suspect the next five years will probably not be as lucrative as the last five and maybe buying geared funds and being overweight mid and small caps at this point may not prove to be such a good idea, I guess time will tell.

Talking of gearing and other stats this portfolio as of early April 2015 would have had weighted average gearing of 14.1%, a yield of 3.76% and a discount of 7.65%. For that you would be paying an average 0.7% in on going charges as calculated by the AIC (equivalent to total expense ratio TER's of old) - not too bad I would say. In addition you would also have / had the issue of reinvesting the dividends, although some ISA managers and Investment Trust Savings Schemes allow for dividend reinvestment if that is something you want / can afford to do & I would certainly recommend it. Alternatively dividends could possible be used to  re-balancing the portfolio, perhaps annually, to try and keep the weightings closer to the starting percentages if that is something you wanted to do. You could of course just let the weighting go where they naturally end up if you wanted to keep it really simple.

Summary & Conclusion
Of course this is just a suggestion of how you could use some IT's to easily replicate / beat the market thanks to gearing and extra exposure to small and mid cap stocks in a diversified professionally managed way without it being too expensive. This would be without all the angst of picking stocks yourself so you can relax and enjoy yourself. Equally as the years go by you could add further trusts to add an international dimension if you wanted to or you could just buy an international generalist like Bankers (BNKR) or Scottish Mortgage (SMT) to make life even easier and cheaper with on going charges of just 0.5% each on these two.

Then the world could truly be your oyster ha ha ha ha ha...sorry that's another musical reference to finish. Click here if you are curious and don't know what I'm on about and have about 14 minutes to spare - must go now go to rock on.