Time to shine

David Prosser examines five ways for investment companies to benefit in 2021.

ShineCompressed

What will 2021 bring investors? The short answer is uncertainty. There are reasons to be positive about the year to come – including respite from Covid-19 via vaccines, the pay-off from a last-minute Brexit agreement and easing global trade tensions courtesy of a more benign administration in the US. But there are plenty of worries too – not least about the economic fall-out of the virus.

There will no doubt be ups and downs. And investors will once again need well-managed collective funds to provide shelter during the more turbulent moments. For that reason, it is worth reflecting on the protections that investment companies afforded their shareholders during 2020; the five attributes that enabled the sector to shine last year will once again be to the fore.

1. Protecting income

Income-focused investors suffered more than most during 2020, with hundreds of companies worldwide slashing dividends as their revenues collapsed in the face of the Covid-19 crisis. It may be some time before such businesses are able to repair the damage.

Investment companies saved the day for many. While half of all UK companies reduced their dividends, only 20% of investment companies did the same. And the 10 or so funds that have increased their dividends in each of the last 40 years or more all managed to do so once again.

Uniquely, investment companies are able to hold back dividend income in good years to subsidise pay-outs in difficult times – and even, in some circumstances, to pay income from capital. This flexibility will continue to prove invaluable.

2. Protecting capital

Income is important, of course, but investors also want to see their capital preserved, even in tough market conditions. Here too there is good news. While the UK stock market’s losses were in double digits during 2020, the average investment company produced a positive return of more than 10%, thanks to the sector’s well-managed exposure to a wide range of international assets.

Nor were discounts a problem. The fact that investment company shares sometimes trade at a discount (or premium) to the value of the underlying assets is a worry for some advisers and investors. They see this feature as adding complexity and increasing risk. However, the average fund ended 2020 on a discount of less than 4%, broadly in line with the position at the beginning of the year.

3. Safe structure

Discounts and premiums are a product of the structure of investment companies. Funds are closed-ended, with investors getting in and out via shares that can be bought and sold on the stock market; that’s a different model to open-ended funds, which expand as more investors join, or contract as investors leave.

Crucially, this structure provides critical safety. Investment company managers never have to worry about inflows and outflows of cash, which can cause open-ended managers so many problems. For example, investment company managers never have to be forced sellers of assets, pushed into dumping assets at the wrong moment in order to meet investors’ requests for withdrawals.

4. Guaranteed liquidity

Investment is a long-term pursuit, but most of us want the comfort of knowing that we can get at our cash quickly if needs be. So when fund managers shut up shop and ban withdrawals, it can feel very disconcerting, even if you don’t actually need access to your money.

That’s what happened in areas such as property last year, with open-ended funds forced to lock down so that investors rushing for the exits did not force them to sell assets in tough market conditions. Investment companies, by contrast, suffered no such difficulties, with their structure once again proving vital. Investors who wanted to trade were able to buy or sell investment company shares at will, irrespective of problems in the underlying portfolio.

5. Vital diversification

Investors are routinely advised not to put all their eggs in one basket, but for most people, spreading their bets beyond equities and fixed-income assets can prove challenging. Areas such as property, private equity and other unconventional asset classes often require very large minimum investments or come with lengthy lock-in periods.

Again, investment companies can come to the rescue, offering highly liquid exposure to a remarkably diverse range of assets, spanning everything from infrastructure and venture capital to structured debt and hedge funds. Last year saw plenty of new opportunities emerge, including funds raising money for investment ideas such as social housing and music royalties. For investors looking to move beyond traditional areas while still maintaining liquidity, the sector offers endless choice.