Racing ahead

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Throughout the long-running debate about the relative merits of open-ended funds and their closed-ended investment company counterparts, one argument has always stood out: the past performance records of the latter have generally been more impressive. But with so many open-ended funds cutting their charges dramatically in recent times, is that still the case? Without the drag from higher costs, have open-ended funds been able to catch up?

The short answer appears to be no, according to new research from the analysts at FE Trustnet. Their study of the 10-year performance records of both open-ended and closed-ended funds in 10 popular sectors puts investment companies ahead in seven out of 10 cases.

In some sectors, the lead is very considerable. The average investment company in the Asia Pacific Excluding Japan sector delivered a gain of 173 per cent over the 10 years to the end of September, FE Trustnet says, against 94 per cent from the average open-ended fund – a gap of 79 percentage points. In the Japan sector, investment companies delivered 165 per cent to open-ended funds’ 91 per cent over the same period – 74 percentage points more

Elsewhere, the gap was more modest, but investment companies also came out on top in Europe excluding the UK, Global, Global Equity Income, North America and UK Smaller Companies. The exceptions in the study were UK All Companies, where open-ended funds were 4 percentage points ahead of investment companies, UK Equity Income (13 percentage points) and Flexible Investment (20 per cent).

What lessons should we draw from this analysis? Well, the first point to make is that past performance is still not to be considered a reliable guide to the future. Still, the study is important: even if we assume investment companies are no longer enjoying significant pricing advantages given the increased competitiveness of open-ended funds since the retail distribution review of five years ago, there are additional factors that seem to be continuing to drive outperformance.

One of those factors is almost certainly gearing: the fact that investment companies are entitled to take on borrowing in order to enhance returns in a rising market. The flipside of gearing, of course, is that it magnifies losses when markets are falling, though investors in equities have presumably already decided they think the good times will outweigh the bad.

Another driver is likely to be structure, though this is harder to quantify. Not only is it potentially distracting and disruptive for open-ended fund managers to have to cope with inflows and outflows of cash from investors, it’s also important that they maintain liquidity in their funds in order to be confident of meeting redemption requests without having to sell assets. As a result, they may often be less fully invested in the underlying asset class than their investment company peers.

It’s also worth saying that the pricing differential between investment companies and open-ended funds hasn’t disappeared in most cases. The gap on charges may have come down now that open-ended funds no longer have to pay commissions to intermediaries, but many investment companies have been reducing charges too.

As ever, there is no guarantee any investment company will outperform its open-ended counterpart over the years ahead, but investors should welcome the increasing competition between these two structures, which is now taking place on a much more level playing field. For now, however, the evidence suggests investment companies have been maintaining their performance advantage.