David Prosser takes a closer look at why more advisers are considering investment companies.
Many advisers will have seen the Association of Investment Companies’ triumphant announcement that 2015 was a record year for fund-raising in the sector. Net fundraising came in at £5.24bn, 56 per cent up on the previous record year of 2007, with both IPOs and secondary issues performing very strongly. As a result, the investment company sector is now worth £134bn, slightly down from May’s all-time high of £137bn, as equities in particular have slipped back, but still more than 10 per cent up on 2014 in a poor year for stock market performance.
Those figures are impressive, but it’s worth standing back for a look at the bigger picture. For the story of the investment company sector over the past three years has really been about re-establishing closed-ended funds as an absolutely mainstream option for the broadest possible range of retail investors.
The retail distribution review (RDR), which came into effect in January 2013, fired the starting gun on that effort. The moment intermediaries could no longer receive sales commissions from open-ended funds, they had more reason to think about including investment companies, restricted in making such payments, in their clients’ portfolio planning.
Nevertheless, the investment company sector has had to give advisers a positive reason to consider buying its funds. In practice, there are many, and investment companies have worked hard to make the case for their competitive edge:
- Cost – charging remains a key battleground for investment companies, which have traditionally been cheaper than open-ended funds, with the savings translating into better performance, particularly over the long term. The ending of commission payments has enabled open-ended funds to cut their charges and take the fight to investment companies – many have responded by moving to lower charging structures themselves;
- Gearing – investment companies’ ability to take on gearing offers opportunities for enhanced returns in rising markets;
- Income – investment companies’ ability to pay smoothed income payments and even to finance income from capital, makes them ideally suited to income-seeking investors, which has been crucial in this low interest rate environment;
- Structure – the closed-ended structure of an investment company means its manager need worry only about investment performance, rather than having to accommodate inflows and outflows of funds;
- Governance – as independent companies with boards that have a fiduciary duty to hold managers to account, closed-ended funds have formal structures through which under-performance will be addressed.
Many financial advisers increasingly recognise these attributes, which is why intermediaries’ purchases of closed-ended funds for their clients has risen so dramatically over the past couple of years. But it’s only to fair to point out that sticking points remain. One issue is liquidity – some advisers, particularly large firms, still worry about whether investment companies are sufficiently liquid to cope with large orders. Independent analysis suggests this should not be a concern for all but the smallest funds, but the sector will need to continue making this case.
Discounts will also remain a bone of contention for some advisers, though at 3.2 per cent as an average across the sector, these remain close to an all-time low. The closed-ended structure mean investment companies always will trade a discounts or premiums, but thanks to policies such as discount control mechanisms, now much more common, these are becoming less of an issue.
In the end, the sector will stand or fall on performance – and its record in this regard is strong. The evidence of 2015 is that more advisers than ever before like the story.