Things on the up for closed-ended funds

Ian Sayers, Director General, Association of Investment Companies

If a week is a long time in politics, then six months must be an age for investment management judging by how far sentiment in the closed-ended sector has changed in this time.

Back in September last year, with markets down from their recent highs, the closed-ended sector looked poised to have its weakest year for new launches for more than a decade. But a round of fund raising towards the end of last year, coupled with a strong rally in markets, has helped to transform sentiment in the sector.

Conventional investment companies in 2012 delivered returns of 14.8%, outperforming the main market and helping the sector to push through £100bn of assets under management for the first time in January 2013.  Discounts also narrowed to their lowest level since 2007.  Relative performance was also strong, with our regular research from Cannacord Genuity showing investment companies outperforming open-ended funds in 14 out of the 16 comparable sectors over 10 years.

Sometimes headline figures only tell part of the story.  Though fund raising via IPOs in 2012 was low at £850m (down from £1bn in 2011), secondary market fund raising was surprisingly buoyant at £2.7bn, resulting in net inflows for the sector of £1.1bn.

As has been the case for a number of years, income has been the dominant theme for most new launches and secondary fund raising.  Indeed, with many income-orientated funds standing at premiums, a number of investment companies have been able to tap out shares on a regular basis.  With interest rates showing no signs of rising in the short-term, I expect the income story to continue for some time yet.

In the midst of all this, the Retail Distribution Review came into force on 1 January 2013 and, with it, the abolition of commission for financial advisers.  As a sector that has been restricted in terms of how and when it can pay commission, we have always suffered from the dominance of commission as a means of remunerating financial advisers.  So we see RDR as one of the most important developments in levelling the playing field with open-ended funds.

But we have been keen to communicate to our members that, though RDR is an opportunity for the sector, it is a long-term one, the benefits of which will not simply materialise overnight because of our better long-term performance record.   We have a lot of work to do with advisers to convince them that investment companies not only can deliver better performance but can be incorporated safely into client portfolios.

Advisers need to understand not only how features like gearing work, but also that they will not suddenly be surprised by the level of gearing an investment company might take on.  So we have been working with our members to produce gearing ranges, to help advisers appreciate that, in most cases, the amount of gearing used by investment companies is modest and many use none at all.

Similarly, we have to educate advisers about issues such as discounts and liquidity, two issues where, rather like gearing, the concerns are often much greater than the reality, but which nonetheless act as a barrier to recommending investment companies.  This is why we started our training programme for advisers 18 months ago and the response to date from advisers has been very positive.  We have trained over 1400 advisers in this time and we have used feedback from these sessions to help our members understand what matters to advisers and why.

Perhaps the most interesting feedback has been the range of investment companies advisers are interested in.  There was a time when the conventional wisdom was that advisers, post RDR, would only be interested in the largest, most liquid ‘plain vanilla’ investment companies.  Nothing could, in fact, be further from the truth.  Though there is interest here, of course, advisers have recognised that the closed-ended structure is ideal for investing in less liquid asset classes such as property, infrastructure and private equity.

But I think there is something deeper here than just the suitability of the closed-ended structure for illiquid asset classes.  Advisers, in a post RDR world, are going to be under pressure to justify their fees to clients, some of whom will be seeing the true cost of advice for the first time.  Many people are predicting a rise in the self-directed investor as a result and there will no doubt be enterprising firms looking to provide solutions to help them do this.

One way to prevent this type of exodus, of course, is to offer something that clients can’t get, or don’t feel comfortable getting, via the self-directed route.  Clients who may feel perfectly comfortable buying a portfolio of tracker unit trusts via an online broker may well feel the need for advice when this can help them explore the long-term benefits of less mainstream asset classes within a well-balanced portfolio.

With problems in the Eurozone continuing to dominate financial headlines, few would be brave enough to predict how the rest of the year will pan out.  But for now, at least, the message from the closed-ended sector is a positive one.