Top 10 adviser questions: Nick Britton shares the most common investment company questions

With the Association of Investment Companies (AIC) adviser training season in full swing, Nick Britton, Head of Training at the Association of Investment Companies has shared the most common questions he’s asked.

Here are the most frequent adviser questions (and answers):

1. I can see that investment companies have performed better than open-ended funds over the long-term, but haven’t they also been more volatile?
   The short answer is yes, and you can look at comparable closed-ended and open-ended sector performance here.  There are two reasons for the additional volatility. First, investment companies may gear (borrow money to invest), which magnifies both positive and negative returns – emphasising those bumps in the road, but also tending to boost long-term gains. There’s also a tendency for discounts to widen when markets do poorly (something that the investment company sector experienced earlier this year) and narrow when they do well, which exaggerates market moves. That’s why we suggest investment companies are most suitable for long-term investors who can buy and hold through a market cycle.
    

2. Are there any limits on how much gearing investment companies can use?
   Each investment company will have its own gearing policy, which can be found in its prospectus or report and accounts. Many investment companies also announce a ‘gearing range’ which indicates the minimum and maximum levels of gearing the board expects to use in normal market conditions. This is often 0-25, indicating a minimum gearing level of 0% and a maximum level of 25%. The gearing range for AIC members can be found on the AIC website in individual member profile pages in the ‘charges and gearing’ section. The average gearing level for all investment companies is relatively modest, around 7%.
    
3. Which platforms are best for holding investment companies?
   This is hard for us to answer, because they all have their own charges and which is best will depend on the individual adviser and client. We would note that many more adviser platforms than before now offer investment companies, and those that saw most investment company purchases in 2015 included Alliance Trust Savings, Ascentric, Novia, Nucleus, Raymond James and Transact. FundsNetwork has just introduced 50 or so investment companies to the platform.
    
4. How are investment companies regulated?
   Investment companies are governed by the Listing Rules of the London Stock Exchange, as well as company law. They also fall under the Alternative Investment Fund Managers Directive (AIFMD), which is a piece of EU legislation that imposes additional requirements for investment companies designed to safeguard the assets and to ensure that the company manages its risks effectively.
    
5. How liquid are investment company shares?
   This depends largely on the size of the investment company. The biggest quarter of investment companies, including many FTSE 250 names, see well over £1 million of shares traded a day according to Winterflood’s research. This goes down to £378,000 for the second biggest quarter, £200,000 for the third biggest, and £70,000 for the smallest quarter. The AIC publishes average trading volumes for individual investment companies on its website.
    
6. How important is the discount or premium to an investment decision?
   Not as important as you would sometimes imagine from the amount of time that is spent talking about discounts! It’s important to be aware of the discount or premium you are buying at, but other factors such as the fund manager’s track record and tenure, the investment strategy and the assets in the underlying portfolio are actually just as important, at least for long-term investors. Investors should remember, though, that premiums and discounts are driven by sentiment – and sentiment can easily change. See a more detailed answer to this question.
    
7. I know the board of directors appoints the fund management group, but who appoints the board of directors?
   For an existing investment company, a nominations committee made up of members of the board will identify suitable candidates. Their appointments need to be approved by shareholders, and each board member, including the chairman, must also stand for re-election at regular intervals. For a new investment company preparing for its IPO, a chairman is generally found first, who will work with the management group and broker to appoint suitably qualified directors.
    
8. Why do investment companies buy back their own shares?
   This is usually done as part of a discount control policy. When the discount at which an investment company trades reaches a certain level (a common ‘trigger’ level is 10%) the investment company may buy back its own shares and cancel them in an attempt to narrow that discount. But an equally important reason to buy back shares is that it can increase the underlying value (NAV) of the shares that remain. This is because the cash used to buy back the shares (remember, at a discount) is less than the value being returned to remaining shareholders when the shares are cancelled.
    
9. What are the best sources of research on investment companies?
   The AIC website is a good place to start; you can get a lot of the essential information and data here in a user-friendly format. The AIC also publishes information on third party websites that provide investment company research, such as Morningstar, QuotedData, Investment Trust Intelligence and Edison. Investment companies are very widely covered by brokers such as Canaccord Genuity, Cantor Fitzgerald, JPMorgan Cazenove, Numis, Stifel and Winterflood. These firms have to declare if the investment company they are researching is a client.
    
10. What is the best process for selecting investment companies?
    You’ll need to develop your own process for selecting investment companies, but it will probably look very like your process for selecting open-ended funds with a few extras tacked on. These extra considerations are: discount or premium, gearing, liquidity and NAV performance (usually, performance figures quoted for investment companies will be based on share price, but NAV performance gives a clearer idea of how the underlying portfolio has performed, regardless of any change in discount). A free webinar for advisers on how to research and analyse investment companies has more details.

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Notes

1. The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment.  Today, the AIC represents a broad range of closed ended investment companies, incorporating investment trusts and other closed ended investment companies and VCTs.  The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help Members add value for shareholders over the longer term. The AIC has 344 members and the industry has total assets of approximately £135 billion.
2. Disclaimer: The information contained in this press release does not constitute investment advice or personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial and, if appropriate, legal advice as to the suitability of any investment decision. Past performance is not a guide to future performance.  The value of investment company shares, and the income from them, can fall as well as rise.  You may not get back the full amount invested and, in some cases, nothing at all.