It’s what’s inside that counts

For financial advisers returning to work, the new year brings pressing commitments thick and fast. From supporting clients with self-assessment tax returns to providing wise counsel on how to use Isa, pension and other tax allowances still remaining, the to-do list is a long one. Still, here’s one more item to add to your new year resolutions in 2020: take some time, if you haven’t done so recently, to get to grips with what the investment companies sector has to offer.

Investment companies started the last decade as an afterthought for many advisers, who tended to rely on open-ended funds to the exclusion of all else. But that began to change from 2012 onwards as regulation levelled the playing field and made it easier for investment companies to compete for advisers’ attention. By last year, advisers were putting record amounts of clients’ money into closed-ended funds.

With good reason. As you survey the investment landscape over the year ahead, here are eight reasons to think about how best to use investment companies:

  1. Investment companies have tended to outperform other types of fund. One recent study by Cass Business School found that investment companies outperform their equivalent open-ended counterparts by an average of 0.8 percentage points a year.
  2. Investment companies are often cheaper. While many open-ended funds have reduced their charges in recent years to make the playing field more competitive on cost, investment companies have been reducing fees too – more than 40 did so in 2019 alone.
  3. Investment companies solve the liquidity trap. Investors who want exposure to illiquid assets such as property or unquoted companies ran into a series of problems with open-ended funds last year, which were forced to shut up shop for extended periods when large numbers of investors tried to take their money out. The structure of an investment company, with exposure to the underlying assets offered through shares listed on liquid stock markets, negates this issue.
  4. Investment companies favour income seekers. Uniquely, investment companies can hold back dividend income in stronger years in order to fund pay-outs in leaner times. The effect is to smooth out volatility. More than 20 investment companies have increased pay-outs to shareholders in each of the past 20 years. Some have done so for 50 years or more.
  5. Investment companies have independent boards. As stock market-listed companies, closed-ended funds must appoint independent directors with a legal duty to protect shareholders’ interests. Last year saw a number of boards change investment manager in search of better returns for shareholders.
  6. Investment companies can take on gearing. Other types of investment fund aren’t allowed to borrow money to invest; investment companies can use these facilities to positive effect, enhancing returns during periods when the markets are rising.
  7. Investment companies are accessible. Investment company shares are eligible Isa holdings and investors typically have the option of drip-feeding money into funds via regular savings plans through platforms and brokers, rather than having to put up a lump sum.
  8. Investment companies offer a way into alternative asset classes. Areas such as private equity, infrastructure and debt have much to offer investors but have traditionally been off limits to all but large institutions. Innovative investment companies give retail investors a means to buy exposure here too.

None of which is to say that investment companies are suitable for all. Share prices rise and fall, so the funds won’t be appropriate for those with limited appetite for risk or short-term time horizons. Some advantages of investment companies can also work against investors. Gearing exacerbates losses during more difficult times, for example, while the closed-ended structure means shares may trade at a premium or discount to the underlying assets, which can be off-putting.

Still, for increasing numbers of investors and advisers, the investment company industry has moved into the mainstream in recent years. There is every reason to expect this trend to continue over the year – and decade – to come.