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Comparing open and closed ended performance during different market conditions

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8 September 2015

A blog by Nick Britton, Head of Training, AIC.

It’s three years now since we began publishing quarterly comparable performance figures for open- and closed-ended sectors, courtesy of our good friends at Canaccord Genuity. 

This ongoing quarterly snapshot is not about point scoring. Instead, it’s about educating advisers about the factors that can make a difference to investment company performance, such as discounts and gearing, and the kinds of market conditions in which closed-ended funds might flourish (and indeed those which might prove more challenging, such as the turbulence we have experienced recently).

Whilst we only have three years of this research under our belts, and the generally benign markets since then have generally worked in investment companies’ favour, there have still been some interesting variations along the way. 

The first quarterly comparison, for the period to June 2012, showed investment companies outperforming their open ended counterparts in ten out of 15 comparable sectors over all three periods we looked at: one, five and ten years.

Investment companies tend to do particularly well in strongly rising markets due to a combination of narrowing discounts and the amplifying effects of gearing, so it’s no surprise that the period from mid-2012 to mid-2013 was an excellent one for the sector. In the year to July 2013, investment companies outperformed equivalent open-ended funds in all sectors but one. In the same month, five- and ten-year returns were superior for investment companies in 12 out of 16 sectors.

Since then, a more mixed picture has been emerging. Investment company performance is still holding up well over the medium to long term to the end of June 2015, with the latest data showing outperformance in 12 out of 15 sectors over five years and nine out of 15 sectors over ten years. However, over one year only six investment company sectors have outperformed their open-ended equivalents.

The figures show that advisers who have not tuned into investment companies have missed out on some strong returns for their clients. But they are also a reminder that the biggest benefits of investment companies accrue to the patient investor: short-term outperformance is very far from being a given, especially during challenging markets.

Investment companies are usually expected to underperform in weaker markets because of widening discounts and the double-edged sword of gearing. While we haven’t seen markets plummeting south in general until last month's turbulence, the past 12 months have contained more than a few notes of caution and, with discounts still at record lows, it could be argued that the scope for further narrowing is limited.  Interestingly, the average discount at the end of August has only widened out 0.4% from the previous month, to 2.9%.

But this is not just a story of discounts and gearing. The closed-ended structure of investment companies, while harder to quantify and appreciate, is at least equally important. Because investment companies don’t have to deal with constant inflows and outflows, fund managers can structure portfolios for the long term. That could mean investing in less liquid assets, keeping less cash on hand to meet possible redemptions, or just choosing the best times to sell assets, rather than being forced into liquidating chunks of the portfolio when investors rush for the exit.

All these factors allow fund managers to run money more efficiently and should, logically, lead to better long-term performance. This is what Canaccord Genuity’s data has demonstrated. Every quarterly update since 2012 has shown investment companies outperforming equivalent open-ended funds in the majority of sectors over both five- and ten-year periods. In key sectors such as Global and UK Equity Income, the run of superior returns has been unbroken.

That’s not to say that, in future, open-ended funds won’t have their moment in the sun, and it will be interesting to see how the tables in Canaccord Genuity’s research might turn if the recent volatility continues. I for one am fascinated to see what the end-of-September data from Canaccord Genuity might look like.

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