Hold your nerve

Deep discounts are no reason to throw in the towel, writes David Prosser.

It’s always darkest before the dawn. That, in any case, is the cliché many in the investment companies sector will be clinging to right now; the industry feels as if it is in the midst of a crisis, with the average fund’s shares now trading at a wider discount to the value of its underlying assets than at any time for 15 years.

Should investors be concerned? Well, widening discounts are never welcome; they mean the value of your holding in the fund does not fully reflect the value of the assets in which you own a share. The wider the discount, the more that is the reality of the situation.

However, while the sector is certainly going through a tough time, there are also reasons for investors to be positive. Funds continue to cut charges, for example – more than 30 investment companies have reduced their fees this year alone. Also, we’re seeing investment company boards take action to tackle discounts. In particular, share buybacks are now commonplace – funds are buying in their shares in order to get discounts down.

Still, there is a broader question here. Do the current issues in the investment companies sector reflect specific problems or weaknesses with funds themselves, or is there something more fundamental going on?

The answer is that investment companies are inevitably exposed to market sentiment. And the structure of the funds makes them more vulnerable to investors’ changing appetites for risk. Downbeat investors selling shares because they feel pessimistic, rather than because of problems in the portfolio, will push the share price down even if net asset value isn’t moving.

There is, on the other hand, no obvious sign of a systemic problem with investment companies. There is no reason to think that the value proposition of the sector – now well over 100 years old – is suddenly broken. We’re not seeing investment companies making disastrous asset allocation mistakes or taking unnecessary amounts of risk. Indeed, many funds report strong net asset value performance.

The travails of investment companies will nonetheless be discomforting for those who own shares in funds. But the key is to remain patient – to stay focused on the long-term benefits of stock market investment. Over time, at least in the past, investment companies have repeatedly and consistently outperformed other types of collective fund vehicles.

For onlookers with no current exposure to investment companies, meanwhile, now might be the moment to consider buying into good funds. You are, after all, being offered an opportunity to secure exposure to assets at a price well below their market value. If and when discounts narrow, this has the potential to deliver a double whammy effect in performance terms.

As for when that might happen, it’s always difficult to predict changes in investor sentiment. But it’s just worth noting that much of the current gloom has been driven by the cycle of high inflation and rising interest rates that we’ve seen over the past two years. Now we seem to be at or close to the top of that cycle, it is possible to see a pathway to better times ahead.