Sister, sister

Faced with a choice between two pretty similar products in a shop, would you choose the cheaper or the more expensive option? It’s not a trick question – most of us would go for the former. And that’s worth bearing in mind when you’re making investment decisions.

Many fund managers today operate both investment companies and open-ended investment companies, often investing in very similar portfolios of assets. However, the structures of the two different types of fund can give rise to anomalies. In particular, the price of investment company shares depends on demand for and supply of those shares on the stock market; and sometimes, that gets out of sync with the value of the underlying assets.

Right now is one of those times. Stock market sentiment was badly affected by the falls on many global markets last year. As a result, the shares of many investment companies slipped to unusually wide discounts to the value of their underlying assets, as demand for the funds fell away. By contrast, open-ended funds aren’t affected in the same way; when investors don’t want these funds any more, the manager gives them their cash back, cancelling units in the fund if necessary.

That has created a situation where investment companies may offer a cheaper way into a particular set of assets. Indeed, new research from Investors Chronicle magazine identifies no fewer than 20 investment companies where this is a potential opportunity.

In each case, the magazine looked at pairs of funds managed by the same investment manager and investing in in very similar portfolios of assets – sometimes called “sister funds”. Examples include Baillie Gifford-run Edinburgh Worldwide, where the shares are trading at a discount of around 19%, and its open-ended equivalent Baillie Gifford Global Discovery. Another example is Polar Capital Technology Trust and Polar Capital Global Technology. Shares in the former are trading at a discount of around 14%.

None of which is to suggest these funds are heading for a period of strong performance, or that they’re right for you. Rather, the point here is that if you’ve decided that you want access to a particular market or asset class, an investment company may currently be a significantly cheaper way to pursue your interest.

It should be said that comparisons are not straightforward. Investment companies can take on gearing, which is off-limits to open-ended funds. But gearing adds to downside risk, which may be one reason why an investment company is valued more conservatively in cautious times. It’s also the case that apparently similar investment companies and open-ended funds sometimes have portfolios that differ more than you might expect. Again, this may explain the discount on the former.

Tread carefully, in other words. If you think you’ve spotted a bargain, it’s important to do a bit of checking – is the discount on an investment company an anomaly or is there a rational explanation?

Still, this is a genuine opportunity. In the current market environment, there are a good number of examples of investment managers running both investment companies and open-ended funds with very similar remits, where the former offers a chunky discount. All other things being equal, you’ll be better off in the investment company because you’ll get a benefit as the anomaly works itself out.