Far out in front

What do investors look for from the collective funds that their financial advisers recommend? In the end, the answer boils down to one word: performance. Investors want to feel that for the level of risk they’re comfortable taking, they’re getting the best possible return on their money, after charges.

In that context, the Association of Investment Companies has in recent days published yet another piece of research charting the way in which closed-ended funds have outperformed their open-ended counterparts over long-term periods. I say “yet another” because the AIC’s research simply confirms the findings of every other analyst that has made such comparisons, including those who could be considered a little less partial than the closed-ended funds industry’s trade body.

For the record, the AIC looked at the aggregate performance of the investment company sector (excluding venture capital trusts) over 10, 20 and 30 years to the end of March 2018.

Over the longest of those periods, the average investment company had returned 1,955%, against 1,196% and 944% from the FTSE All-Share and MSCI World stock market indices respectively. Open-ended funds, on average, managed 919% over the same period.

Over 20 years, the average investment company was up 510% against 170% from the All-Share and 231% from the MSCI World Index, with open-ended funds delivering an average of 214%.

Over 10 years, investment companies delivered 144%, still ahead of the All-Share, which produced 91%, though slightly behind the 151% from the MSCI World Index. Open-ended funds returned 96%.

In other words, over all three periods, the average investment company delivered higher returns than the average open-ended fund and also beat the UK stock market. In two out of three cases, it was ahead of the world market too.

The comparisons should tell us a couple of things. First, that investment companies offer a powerful counter argument for those analysts who insist the days of active investment management are numbered. There may indeed have been a huge shift of investors’ funds into passive vehicles over the past two or thee years, but actively-managed investment companies continue to prove it is possible to consistently beat the market over the long term.

Second, the numbers again show that advisers who continue to ignore investment companies – and while adviser purchases are now soaring, they still lag open-ended fund purchases by some distance – are likely to be doing their clients a disservice. Time and again, investors in closed-ended funds have done better than their counterparts in comparable open-ended vehicles.

Why is this the case? Well, one traditional argument has been lower charges – for many years, investment companies were able to offer keener pricing because the funds weren’t able to pay commissions to intermediaries.

That hasn’t been the case for the past six years, of course, since the retail distribution review outlawed all commission payments, and we have certainly seen open-ended fund charges come down markedly. Investment companies have attempted to cut their own fees too, but it’s fair to say the charging advantage is no longer so significant.

Nevertheless, other factors remain as valid as ever. The fact that investment companies may take on gearing gives them an edge, since borrowing boosts returns in a rising market. The opposite is true in a falling market, you might argue, but advisers who think the market is set to fall more than rise over the longer term are presumably avoiding it altogether.

Structure is important too. The closed-ended set-up of an investment company means the manager does not have to worry about inflows and outflows of cash, or keep a close eye on liquidity. The cash positions of investment company portfolios tend to be correspondingly lower, with more invested in the funds’ underlying assets. Over time, this greater market exposure boosts returns.

Finally, there’s the governance issue. Investment companies are independent structures run by boards with a legally-binding fiduciary duty to act in the interests of shareholders. In recent years, boards have exercised this duty ever more actively, intervening to protect shareholder value in instances where performance has disappointed – even replacing the manager if needs be. Again, the effect over time is to support long-term performance.

None of which is to suggest that investment companies will always beat open-ended funds – let alone that an investment company is always the right choice for an adviser’s clients. But what the performance figures do show, over and over again, is the compelling case for paying closed-ended funds more attention.