A different offering

Four years after the Retail Distribution Review (RDR) reforms finally levelled the playing field for investment companies seeking to compete against their open-ended counterparts, funds continue to roll into the closed-ended fund sector. But the money has come not only from allocations from financial advisers, for whom the banning of commission under RDR prompted a new look at investment companies, which unlike open-ended funds have never paid such fees. Investors are also choosing investment companies on an execution-only basis.

New data from the research specialist Cerulli Associates suggests the value of closed-ended funds has increased by 16 per cent over the past four years. That reflects rising asset values, share issues and new launches in the sector, with the additional value spread throughout the industry.

One major attraction, says Cerulli, has been the opportunity to get exposure to illiquid assets via closed-ended funds. The structure of an investment company is well-suited to investment in assets such as infrastructure, private equity and property, because investors moving in and out of the funds have the benefit of the liquidity available in their stock, no matter how illiquid the underlying asset might be.

Moreover, these alternative asset classes have been extremely popular with income-seeking investors in recent times, with yield in short supply from conventional investments because of the Bank of England’s low interest-rate stance.

"A major attraction of closed-end funds is their structure, incorporating a permanent pool of capital not affected by day-to-day fluctuations in investor demand,” argues Barbara Wall, managing director of Cerulli’s European arm.

The problems in the open-ended property fund sector last year underline the point. Several funds were forced to close for a period, as investors rushed for the exit in the wake of the Brexit referendum decisions. Closed-ended funds, by contrast, suffered no such problems, since investors who wanted out were simply able to sell their shares on the open market.

Beyond illiquid assets, however, investment companies are also thriving. Fixed-income funds have doubled in value over the past four years according to Cerulli, while equity funds are up by well over 50 per cent. The research firm also points to a significant increase in the volumes of retail investors buying investment trust shares via platforms.

It’s a fascinating example of how regulatory reform can change the dynamic of a market – and sometimes very quickly. While the total value of closed-ended funds is still small relative to the open-ended sector, the growth of the investment company sector has been remarkable. And while some financial advisers still have reservations about recommending investment companies to clients, they’re increasingly in the minority.

On performance grounds alone, that shouldn’t be surprising. Independent analysis frequently suggests that closed-ended funds tend to outperform their open-ended counterparts when investing in the same pools of assets. The fact that investment companies can take on gearing is one factor in that – and some advisers may be uncomfortable with this – but there are other explanations too.

None of which is to suggest advisers should consider this to be a binary equation. There will be a place for both types of fund in many clients’ portfolios, depending on their individual needs, aspirations and attitude to risk. Still, it’s encouraging to see closed-ended funds back in favour – for the sector’s own sake, of course, but more because they so often offer investors something different.