Navigating the crisis

David Prosser takes a look back at the sector’s admirable performance during a year like no other.

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It’s been a terrible year for investors and investment markets, right? Well, if it is the FTSE 100 Index of leading companies on the UK stock market you’re looking at, the chaotic impacts of Covid-19 are plain to see – the index is down 13.3% since the start of the year. On the other hand, if your money is in investment companies, things don’t look so bad – as the AIC’s review of the year reveals, the average fund was up 10.2% for the year to 11 December.

In one sense the comparison is disingenuous. Investment companies invest far and wide – in stock markets all over the world, as well as in other asset classes – so they were bound to post different performance figures to the blue-chip UK index. But there is an important underlying principle to recognise here: while it is tempting for UK-based investors to focus on UK investments, portfolio diversification offers huge benefits. And investment companies represent a terrific opportunity to obtain that diversification efficiently and economically.

Investors and intermediaries alike continue to recognise this in ever-growing numbers. The investment company industry’s assets hit an all-time high of £221.4bn at the end of November, the AIC reveals. Partly that growth has come from the performance of funds’ existing portfolios – those 10%-plus returns – but we have also seen healthy levels of fundraising. Secondary issuance worth £6.2bn plus eight brand new funds picking up £1bn from IPOs isn’t bad for a year in which the climate has hardly been conducive to asking investors to part with more cash.

What we’re seeing here is an ongoing sea-change. It is now almost eight years since the retail distribution review changed the funds landscape in the UK so fundamentally, finally ending commission structures that incentivised intermediaries to favour open-ended funds over investment companies. Given a level playing field on which to compete, the investment company sector continues to thrive.

It has had to raise its game to do so. The RDR also enabled open-ended funds to reduce their charges, threatening an advantage that investment companies have long enjoyed. But the sector has followed suit – more than 30 investment companies have restructured their charges in the past year alone. We have also seen investment company boards assert their independence, taking tough action where funds’ performance has disappointed; the AIC points to seven significant management group changes during 2020.

More fundamentally, the lure of investment companies is that they offer all investors, large and small, the same opportunities to build diversified portfolios of assets – including in areas that have often posed dangers or even been off-limits.

The former category includes commercial property, where investment companies provide a liquid entry point to an illiquid asset class, unlike open-ended funds in this area which have had to shut up shop for large chunks of the year. In the latter, think of investment companies that invest in infrastructure, in private equity or in innovative new areas ranging from music royalties to the debt market. These are opportunities that have traditionally only been open to high-net-worth or institutional investors.

None of which is to say that investment companies are perfect, or even that they are always the right choice for advisers and investors. But the experience of 2020 has been hugely positive. Investment companies are sometimes accused of being more risky – they take on gearing, for example, and their share prices trade at discounts or premiums to the value of their underlying assets – but if ever there was a year where such worries would come home to roost, 2020 has been in it. In fact, the sector has had a remarkably good crisis.