The road ahead for investment companies

You might call it an “annus horribilis”. In 2022, the investment companies sector endured its worst year of performance since the global financial crisis, new analysis from the analyst team at Winterflood reveals. The FTSE All Share Closed End Investments index fell 16.6% over the year as a whole, a period in which the FTSE All Share Index managed to stay in the black, albeit with a gain of just 0.3%.

It's not an entirely fair comparison. The All Share Index measures the performance of the UK stock market; the investment companies sector, by contrast, is exposed to the fortunes of global stock markets too, as well as to a wide range of other asset classes. Still, there’s no getting away from the reality that this was a tough year for closed-ended funds.

The extent of the challenges faced last year is underlined by another startling statistic: 2022 was the first year since 1978 when not a single new investment company joined the London Stock Exchange. There was just not enough appetite for new issues from the sector, even in the more in-demand alternative asset classes where investment companies are so strong.

Not all of last year’s decline was down to poor performance. While managers did struggle to drive net asset value forwards, the bigger problem was the valuation of investment company shares. The average fund began the year with its shares trading at a 2.5% discount to the value of its assets; by the end of the year, that figure had increased to 13.3%.

The million-dollar question for advisers is where we go from here. The investment companies sector has built a growing following amongst many intermediaries over the past decade, particularly since the retail distribution review levelled the playing field with open-ended funds on cost structures. Should they keep the faith?

There are two answers to that question. In the short term, it’s very difficult to make predictions. Winterflood, for one, is optimistic about the year ahead for investment companies, particularly since those wider discounts offer opportunities to get into good funds at lower price points. But the macro environment remains hugely fragile – war in Ukraine continues, inflation remains very high, and the growth outlook for the world economy, and particularly the UK, is weak.

The longer term is a different story. All the drivers that have attracted growing numbers of advisers to the investment companies sector remain in place. The long-term outperformance of closed-ended funds versus their open-ended equivalents is well-established, supported by structural advantages such as the ability to gear, competitive charging practices, and the stability of a fixed pool of assets. It’s also the case that investment companies continue to reach the assets that other funds don’t – illiquid classes such as infrastructure, private equity and real estate, as well as new areas of the market.

In other words, while there can be no guarantees that investment companies will come roaring back over the course of 2023, there is every reason for advisers to remain positive about the longer term. That might lead them, of course, to hunt for those short-term opportunities.

Some are certainly prepared to be patient. The review by Interactive Investor, the online platform, of its “Super 60” recommended funds list makes interesting reading; four of the five worst performers on the list last year were investment companies, but none of them have been chopped from the selection. One investment company was taken out of the Super 60, but one was added too.

The bottom line is that investment in risk assets inevitably means accepting the possibility of volatility, particularly over short periods. And there will be times when investment companies are particularly volatile, because of factors such as their gearing and asset class exposures. Still, there are plenty of good reasons to hope for better years ahead.