David Prosser takes a look at the closed-ended sector two years after RDR.
Two years after the retail distribution review gave the investment company sector the ability to compete on a level playing field with open-ended funds – and therefore the incentive to raise its game – how much progress has been made? The answer, says Alan Brierley, director of the investment companies team at Canaccord Genuity, is a great deal. However, Brierley also cautions: “Now the hard work begins”.
Brierley’s warning comes in his 2015 Investment Companies Handbook, which is essential reading for financial advisers taking an interest in the closed-ended fund sector. He argues that many investment companies have taken a giant leap forward over the past couple of years – but also concedes that not all funds have come so far.
The good news for advisers is that the sector has much to offer. Now RDR means that investment companies can be judged on their own merits – rather than judged adversely for their inability to pay commissions – more intermediaries are beginning to grasp their attractions. “Greater recognition of inherent competitive advantages and the long-term performance record has broadened the investor universe, while demand for alternative assets has seen the evolution of a new generation of companies,” Brierley says.
A sharp narrowing in the discount at which the average fund’s shares trade relative to the value of its assets has certainly helped, since this issue has historically been one with which some advisers have struggled to get to grips. Across the industry as a whole, the average fund now trades at a discount of just 3 per cent – a 40-year low.
Rising asset prices have contributed to that narrowing, but investment company boards have done their bit, with initiatives such as share buybacks and discount control mechanisms.
Elsewhere, too, the sector has tried harder to compete. For example, we have seen a series of funds reduce their charges over the past year. We’ve seen more investment company board directors and fund manager put their money where their mouth is by investing in their own funds. We’ve seen gearing used effectively to boost returns. And we’ve seen more boards prepared to intervene to take action when performance has disappointed.
There’s no doubt that the investment company sector offers certain inherent advantages for investors and their advisers over other types of collective fund – including the ability to gear, structural benefits and a stronger governance model. But what has been particularly gratifying since RDR is the extent to which funds have sought to play to those strengths – they have recognised the opportunity to take on the open-ended sector.
Not that open-ended funds have taken this competition lying down. Above all, now freed from the cost of paying commissions, they’ve been able to cut their charges – so much so that many are now highly competitive on cost.
Equally, as Brierley points out, not all investment companies have been as proactive as the best funds – and the strong performance of certain markets has allowed them to get away with that. “This report features many great companies,” Brierley says. “However, there are also some distinctly average ones, where strong net asset value gains have been driven by highly supportive tailwinds rather than the generation of alpha – a more challenging environment is likely to expose these.”
For investment companies which fall into that category, the challenge now is to put things right before market movements expose their shortcomings. For financial advisers, however, the challenge is a little different – it is to help clients to take advantage of the opportunity that the best investment companies so clearly offer.
What the analysts say this week
Sam Murphy, Numis Securities
“Nick Train’s impressive record as manager of Finsbury Growth & Income continued in 2014, generating net asset value total returns of 6.9 per cent versus 1.2 per cent from the FTSE All Share benchmark. He has now outperformed in 11 of his 14 years as manager. The portfolio is high conviction, consisting of 23 holdings focused on strong consumer franchises with a global perspective. To say he has a long term approach is an understatement; portfolio turnover is 5.5 per cent a year, lower than a tracker, and no new companies have been introduced into the portfolio for three years.
“The fund’s yield of 1.9 per cent is low compared to the UK Equity Income peer group average, but it has a progressive dividend policy, and dividend growth from the portfolio was 9.0 per cent in 2014. Finsbury Growth & Income is currently trading on a 1 per cent premium and regularly issues shares to meet investor demand. Given its strong track record and differentiated approach, we view Finsbury Growth & Income as one of our favoured UK Equity Income funds.”
Charles Cade, Numis Securities
“BlackRock North American Income has repurchased 20 per cent of its share capital at a price of 123.24p, equivalent to a 2 per cent discount to the net asset value on 2 February 2015. 26.69 per cent of the share capital elected to tender, and shareholders will have their basic entitlement satisfied plus 61 per cent of the excess under the mix and match facility. Following the tender, the company’s share capital consists of 80.3 million shares, equivalent to a market cap of £95m. It came as little surprise that the tender was oversubscribed given that the fund has been trading on a discount of around 7 per cent
“BRNA remains sub-scale with a market cap under £100m, and the performance to-date has been disappointing relative to the US equity market. However, it is an interesting mandate and we believe that there remains scope for the fund to grow over time through regular secondary issuance provided its performance picks up. We continue to favour JPMorgan American for investors seeking mainstream US equity exposure, but it is trading at a 1 per cent premium, and we recognise that BRNA has scope for a rerating.”