David Prosser compares open-ended funds and investment companies.
Comparing open-ended funds and closed-ended investment companies used to be very straightforward. Since the former paid commissions to financial advisers while investment companies weren’t able to, the closed-ended sector offered substantial savings. Compare an investment company and an open-ended fund with similar investment mandates and you would always have found that the former was cheaper.
Since the retail distribution review of 2013, however, this issue is no longer so clear cut. Now open-ended funds have been barred from paying commissions, they’ve been able to reduce their fees. Many have taken the opportunity to do so and are therefore significantly more competitive against their closed-ended rivals.
There’s a certain irony here. Since RDR, independent financial advisers have been much more receptive to the idea of investing clients’ funds in investment companies. At the same time, however, one of the most compelling rationales for the closed-ended sector, its competitive advantage, has been eroded.
Still, it’s important to make the point that eroded is not the same thing as washed away altogether – investment companies continue to offer excellent value. Moreover, as an analysis published this week by Morningstar, the investment research analyst, points out, many closed-ended funds have responded to open-ended fund price cuts by introducing reductions of their own.
In fact, since January 2013, when RDR came into effect, 79 investment companies have reduced their charges. Some have chosen to scrap performance-related fees. Others have opted to cut their annual management charges. And in a few cases, funds have taken both these approach, or simply set caps on maximum fees.
The result is a sector that now offers even greater value than in the past. In the UK Equity Income fund sector, for example, Morningstar says the average investment company has an average ongoing charge of just 0.74 per cent. City of London and Temple Bar, the two cheapest funds in the sector, respectively charge 0.44 per cent and 0.48 per cent a year – that’s below the cost of many open-ended funds offering automated passive management.
In the UK All Companies sector, meanwhile, charges are only fractionally higher. The average ongoing charge in the sector comes in at 0.77 per cent a year. Schroder UK Growth levies a fee of only 0.47 per cent a year, while Mercantile Investment Trust is almost as cheap, at 0.5 per cent.
Nor do closed-ended funds offering exposure to international equities necessarily have to be much more costly. In the Global sector, for example, the average ongoing charge is only 0.81 per cent, while in the Global Equity Income sector, funds average 0.85 per cent a year.
There are, of course, more expensive funds in the closed-ended sector, particularly amongst those with more specialist mandates, just as costs vary in the open-ended sector. And there is no doubting that the gap between closed-ended funds and their open-ended equivalents has narrowed. Still, the broader point is that investment companies continue to offer great value.
Do charges matter? Well, Morningstar points to the example of star fund manager Neil Woodford, who for many years ran both the open-ended Invesco Perpetual Income fund and the closed-ended Edinburgh Trust with similar mandates and portfolios – over a five year period, fee structures helped the latter outperform by 10 per cent.