RDR – five years on

The end of the year inevitably represents an opportunity to take stock, but for the investment company sector, the last day of 2017 marks a particularly significant anniversary: it is now five years since the Retail Distribution Review (RDR), the regulatory shake-up that changed the way financial advisers in the UK operate.

For investment companies, RDR was a watershed moment. For years, advisers recommending open-ended funds to their clients could earn sales commissions from that process, but this remuneration model was not open to closed-ended funds; surprise, surprise, sales of the former massively outstripped sales of the latter. Following RDR, however, commissions were banned across the whole market. That gave investment companies a level playing field on which to compete.

Half a decade later, has the sector been able to capitalise on RDR? Well, data covering the year just gone makes interesting reading. 2017 was a record year for secondary fund-raising, with investment companies picking up almost £6bn of new money from investors; demand across the sector, moreover, pushed the discount at which shares in the average investment company trade relative to the value of its assets to an all-time low of 1.8% during the first half of the year; most strikingly of all, sales of investment companies made via financial advisers and wealth managers also hit a record high, with the AIC now predicting these sales may top £1bn for the first time in 2018.

These results were by no means guaranteed at the time of RDR. The fact that advisers suddenly found it easier to recommend investment companies did not mean they would actually do so – many knew very little about closed-ended funds and certainly didn’t automatically feel comfortable putting clients’ money into the sector.

Moreover, while investment companies’ long-term performance record has consistently been superior to their open-ended counterparts, at least part of the explanation for this has been the latter’s higher charges. Freed from an obligation to pay commissions, many open-ended funds were able to cut their fees; that could have undermined the appeal of investment companies.

In practice, two things have happened on charges. First, many open-ended funds have indeed cut their charges; but second, so too have investment companies, often maintaining their cost advantage. As for advisers’ lack of knowledge of the sector, that has changed dramatically too – not least courtesy of the training programme conducted by the AIC nationwide.

The result is the majority of financial advisers now understand the potential benefits that investment companies can offer – not just cost competitiveness, important though that is, but clear structural advantages too. The closed-ended nature of an investment company frees the manager from the tyranny of fund inflows and outflows, enabling them to focus on portfolio management – and to invest in a broader range of assets, including illiquid holdings.

It’s noticeable that many of the sectors where secondary fundraising was particularly buoyant during 2017 – infrastructure and property, for example – fall into this latter category, with closed-ended funds offering investors an accessible way into asset classes that are very often otherwise off-limits.

Looking ahead, there will no doubt be bumps in the road. In particular, the long bull run of the global stock market has provided investment companies with a fair wind, and a reverse would pose challenges – just as it would for other collective investments. Five years after RDR, however, the evidence of 2017 is that the investment trust sector is in a better place than ever.