Do we have too many investment companies?

Do we have too many investment companies? I ask the question after reading an increasingly ill-tempered debate on one of Citywire’s investment forums; some contributors bemoaned the difficulty of choosing from 400-plus investment companies while others attacked the first group for their lack of sophistication or dislike of change.

Supporters of the investment company sector might, of course, be tempted to point to their open-ended fund counterparts, where several thousand funds now vie for the attention of investors and their advisers. But that would be a cheap shot – the question here, for every part of the collective investment vehicle industry, is whether we have funds that don’t deserve their place in the market.

After all, if every single investment company is fulfilling its mandate to deliver superior performance on behalf of its shareholders, why would you want to slim down the universe of available funds at all?

The reality, of course, is a little different. We can all name investment companies that have too long a track record of delivering lacklustre returns, just as we could reel off a list of open-ended funds that deserve to be put out of their misery.

In that sense, we probably do have too many investment companies. Funds charging investors fees for a service that they are not delivering – outstanding investment management – shouldn’t expect to be allowed to soldier on indefinitely. However, there are nuances to this argument. One is that almost all funds do go through periods of below-average performance; they may be invested in an out-of-favour area of the market, for example, or they may be managed according to a style that is bound to underperform in a certain economic or market environment. This is not to say such funds are poorly managed or do not have a future; their day may be yet to come.

Choice is something of a poisoned chalice, as some of Citywire’s contributors observe; it requires people to exercise judgement even though they may be ill-equipped to do so. Nonetheless, every investor is unique – their financial planning needs vary, they come to each new investment decision with a different set of existing investments, and their attitudes to risk are never the same. We need a diverse range of funds to cater for this variation.

It’s worth pointing out too that investment companies excel at both agility and self-selection. This is an industry whose leading lights – once focused on the railroad industry or forestry, say – have constantly reinvented themselves as investors’ needs have evolved. Investment companies are structured in such a way as to protect investors from poor management: they have boards to hold managers to account and, ultimately, can be consolidated through M&A.

In practice, this has lead to an industry where invention has flourished. The steady flow of investment company launches over many decades reflects the need to better cater for investors with changing needs, from the launch of emerging markets funds in the 1980s and 1990s all the way through to the emergence of debt funds aimed at income seekers in recent years. Inevitably, some launches flourish while others flop and often disappear, but such innovation is surely to be welcomed. None of which is to say there are no mediocre investment companies – and it’s true that choice can be confusing. Financial advisers can certainly earn their money here. Still, a much smaller investment company industry would struggle to offer the diversity that its investors need, or to stimulate competition and innovation. And that would be to investors’ detriment.