Investment company sector 2016 performance

What to make of new figures from Winterflood Investment Trusts revealing that the investment company sector delivered an average total return of 16.6 per cent during 2016, slightly down on the 16.8 per cent achieved by the FTSE All-Share Index? On the one hand, you might say that closed-ended funds delivered solid performance in a year of market volatility; on the other, you might be disappointed by the slight market underperformance. After all, in 2015, as Winterflood points out, the sector was up 5.2 per cent against 1.0 per cent from the market as a whole.

By and large, investment companies should outperform when the market is rising (and underperform during down periods). The gearing they employ naturally exaggerates the underlying returns from their portfolios. Moreover, the discount at which funds’ shares trade relative to the value of their underlying assets has a tendency to narrow during stronger periods of market performance, boosting share price returns.

In fact, Winterflood’s long-term data shows evidence of that outperformance. Over the 10 years to the end of 2016, the sector was up by 91 per cent compared to 72 per cent from the FTSE All-Share Index. Investment companies beat the market in six of the past 10 years, and in four of the past seven years; two of the years in which they lagged were periods when markets fell back.

Did something change last year? Well, while the underperformance was pretty marginal, Winterflood suggests it was significant. “We believe that the sector is becoming more defensive, reflecting the changing nature of the investment trust universe”, its analysts say. By the end of last year, 37 per cent of the sector’s assets were held in asset classes other than equities, against 25 per cent 10 years previously.

Another way of putting that is to say that a comparison between the sector’s performance and the returns delivered by the FTSE All-Share Index is no longer valid. We’re not comparing like with like now that more than a third of investment company assets aren’t stock market holdings.

It’s also worth pointing out that while markets did rise in 2018, the average investment company discount widened a little, from 4.4 per cent to 5.7 per cent, reflecting the uncertainties that often unsettled financial markets during a turbulent year. Nevertheless, that figure sits well below the 7.3 per cent average discount recorded over the past 10 years, let alone the 9.5 per cent average going back to 1989.

Moreover, these composite figures are, in one important sense at least, meaningless. What matters to investors is not how the sector as a whole performed, but what happened at the funds in which they were invested – or might consider investing in during the years to come. To answer those questions, you need to pay attention to individual fund performance data.

Still, these reflections on 2016 and beyond do give us pause for thought. The investment company sector is an increasingly diverse collection of funds offering a broad range of opportunities to investors with very different needs and ambitions. Its long-term performance record remains impressive, with key indicators moving in the right direction. But as ever, investors and their advisers will need to identify the right funds for their particular circumstances.