A good first half

After a stellar 2017 in which share prices rose month after month without fail, the first half of 2018 felt rather uncomfortable. The prospect of trade wars, the diverging growth story and the threat of tighter monetary policy – not to mention Brexit uncertainty in the UK - combined to produce a rocky ride for investors. The UK market finished the half year up, but only barely, and many areas of the market were down.

The good news for investors and advisers with exposure to investment companies is that they have very often done better than the market. Data from Numis Securities suggests that across distinct areas of the UK market, investment companies consistently outperformed during the first six months of the year.

So, for example, while the FTSE All-Share Index delivered a return of 1.7 per cent over the six months to the end of June, the average investment company in the UK All Companies sector was up by 6.8 per cent in share price terms. The average UK Equity Income investment company, meanwhile, delivered a share price return of 2.1 per cent during the first half.

Elsewhere, while the FTSE Small-Cap Index was up 0.1 per cent over the first half, the typical smaller companies fund generated 8.1 per cent. The FTSE Mid-Cap Index delivered 1.9 per cent against a 2.3 per cent gain from mid-cap investment companies. And the FTSE 350 High Yield Index was 1.2 per cent higher, while the UK High Income investment companies sector delivered an average of 1.5 per cent.

Beneath these averages, of course, performance was diverse. Some investment companies achieved much greater returns – an impressive 22.5 per cent from Independent Investment Trust, for example – while others did less well. It should be acknowledged that not every investment company ended the half-year in positive territory.

Still, the headline numbers are reassuring. They paint a picture of a sector that continues to underpin the case for active fund management at a time when the trend towards passively-managed index trackers sometimes seems inexorable.

Why are investment companies outperforming? Well, there are a number of reasons. Gearing certainly helps, boosting returns during rising markets and helping funds to outpace the wider market. In some cases, discount movements have helped too – the UK All Companies sector’s strong performance was aided by a narrowing of the discount at which shares in these funds trade relative to the value of their underlying assets.

Above all, however, what investors are getting from investment companies is independent and often unconstrained fund management. The sector has always been less inclined to the practice of closet tracking – where investors pay for active management but get something very close to the index – with the courage to follow its convictions. And the board structure of an investment company means managers are held to account when things go wrong.

Investment companies won’t always beat the market. Gearing means they’re likely to do less well when share prices are falling, particularly over an extended period. Managers will make poor decisions from time to time. Charges, though competitive, means funds start further back and must catch the market up.  Nevertheless, time and again in recent years, investment companies have delivered outperformance.

One final thought. For years, investment companies have extolled the virtues of regular savings plans, which have long been regarded as a means to attract a broader range of retail investors into the sector. The choppy markets we saw during the first half of the year are the sort of environment in which regular savings schemes really come into their own, with the theoretical smoothing benefits of pound-cost averaging – your fixed monthly investment buys more shares in months when prices have fallen, boosting your investment on the recovery – delivering in practice.