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At the helm

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18 October 2019

David Prosser explains the benefits investment company boards offer to shareholders.

If there were one reason above all others to favour investment companies over different types of fund structure, what would it be? There are lots of potential answers, from structural advantages such as the ability to take on gearing, build up dividend reserves and cope with illiquidity to statistical benefits – the long-term outperformance of the investment company sector. But for me, one fundamental plus point outranks all the others – and the clue is in the name.

Unusually for the financial services industry, which loves its jargon, an investment company is exactly what the term suggests. It is a company set up for the purposes of investment. This has important consequences: crucially, like any other company, an investment company must abide by company law, with all the safeguards it provides for the business’s shareholders.

Most notable of all is the requirement for companies to operate with independent boards of directors who each have a legally binding duty to act in the best interests of all shareholders. This is no different in the investment company world; fund management companies can – and do – launch new investment companies as they see fit, but each one must be overseen by an independent board. This board then contracts with the fund management company to secure its asset management services.

So far, so technical, but there’s a logical conclusion to this principle. If the board decides that retaining the services of the fund manager is no longer in the best interests of shareholders, it can (and should) shop around for a better alternative.

This happens more frequently than is often realised – there have been two examples this month alone. European Investment Trust has in recent days announced that it is letting go if its current fund manager, Edinburgh Partners, after an extended period of disappointing performance, and appointing Baillie Gifford instead. It follows Jupiter European Opportunities’ decision to drop Jupiter Asset Management, which gave the fund its name; the fund has opted to follow star manager Alex Darwall as he moves from Jupiter to set up his own firm.

Such changes can often feel brutal. Edinburgh Partners is entitled to argue that its style of investment has been out of fashion for a period but may be due a comeback. Jupiter can be forgiven for feeling sore that a fund it got off the ground and supported will now be going elsewhere.

Nevertheless, the overriding principle here is that the shareholder – the investors in the fund - is the party who must be protected at all costs. It’s a powerful statement that investment companies are run for the benefit of those who invest through them, rather than for those earning a living through managing this money, advising on the process, or servicing the business.

It’s also a completely different model to the open-ended fund sector. An open-ended fund is simply an investment product, marketed by the manager to attract buyers; it has no structure of accountability or fiduciary duty. As a result, while dissatisfied investors have the option of voting with their feet and selling up, they can’t rely on anyone else to look out for their interests.

Investment company boards aren’t infallible. They haven’t always been as quick to intervene on shareholders’ behalf as one would hope, though boards have become increasingly active in recent years in a variety of different ways. And a board that changes manager may, in hindsight, come to regret the decision.

Still, the principle could hardly be more basic and vital. The fact an investment company exists only to serve its shareholders – with the full weight of the law sitting behind this truth – is a compelling argument for favouring the sector that feels impossible to trump.