Don’t blindly buy a tracker – this fund has grown 12 times more than the FTSE 100 (and is cheap)

Brunner’s wide discount and strong track record of outperformance mean it remains a valuable purchase

Actively managed funds have become the pariah of the investment world. In the US, assets under management in passively managed or “tracker” funds recently exceeded those in actively managed funds for the first time in history.

This is wholly unsurprising, since a whole generation of new investors are continually being told to simply buy funds that track the performance of an index because of their lower fees, greater diversification and typically superior long-term performance.

In Questor’s view, actively managed equity funds such as the Brunner investment trust highlight why the current consensus to solely back passive funds should not be followed blindly. Since first being tipped as a “buy” in this column in April 2017, the company has generated a capital gain of 85pc. By contrast, the FTSE 100’s capital return stands at just 9pc over the same period.

In the past five years, the trust has outperformed its benchmark. While a 70/30 split between the FTSE World ex-uk index and the FTSE All-share index has produced a 64pc total return, the company’s performance is a full 19 percentage points ahead. This is in spite of its shares trading at an 8pc discount to the underlying value of its assets.

Indeed, many investment trusts offer the chance to buy stocks for less than their market value. This provides scope for greater returns over the long run, since discounts have proven to be temporary. They can even become premiums during more bullish stock market periods, thereby further enhancing overall returns.

Actively managed funds can also offer a more stable dividend profile than their passively managed peers. Brunner, for example, has raised dividends for 52 consecutive years. It has been able to do this because investment trusts can retain up to 15pc of the annual income they receive from their holdings in a revenue reserve that can then be used to top-up dividends paid to investors during leaner years. By contrast, passive income investors must make do with the inherent dividend fluctuations of tracker funds. And with the company’s dividends having risen by 4,629pc over the past 52 years, versus total inflation of 1,588pc over the same period, its investors have enjoyed significant real terms growth in their income.

Although Brunner’s gearing ratio (the value of the fund’s borrowing compared to its assets) stands at a relatively modest 5pc, it will magnify the trust’s returns over the long run. While this also means greater volatility in the short run, the stock market has always posted new record highs over extended time periods. As a result, long-term investors are likely to be beneficiaries of the use of debt by investment trusts. Of course, tracker funds generally offer greater diversification than actively managed funds. Brunner, for example, has just 60 stocks in its portfolio versus hundreds of holdings for most index tracker funds. Its 20 largest positions, which include stocks such as Microsoft, Taiwan Semiconductor and Intercontinental Hotels Group, account for about 55pc of total assets. This means that changes in their share prices could affect the trust’s overall performance. Alongside the presence of gearing, this can mean greater volatility compared to passive funds.

Furthermore, charges paid by investors for actively managed funds are higher than for tracker funds. But as Brunner’s past performance shows, higher costs can be more than offset by greater returns and a more reliable income stream. Moreover, paying for a professional management team to, at the very least, avoid financially unstable, overvalued companies that lack a clear competitive advantage is, in Questor’s view, highly worthwhile. In Brunner’s case, a bottom-up approach that does not necessarily favour a particular industry or country allocation has proved to be successful. And with the stock market offering mispricings as investors become overly emotional about specific companies and industries, there will always be opportunities for active investors to generate index-beating returns.

Therefore, while growing demand for passively managed funds is unlikely to cease in the short run, it would be unsurprising for actively managed funds such as Brunner to become more popular in the long run. Its relatively high historical returns, stable income track record and wide discount mean it remains a worthwhile purchase.

In Questor’s view, long-term investors should consider it, as well as many other actively managed funds, before blindly accepting the consensus that tracker funds are the best option.

Questor says: buy

Ticker: BUT

Share price at close: £12.60

‘Passive income investors must make do with the inherent dividend fluctuations of tracker funds’