David Prosser analyses the investment company sector’s outperformance.
The analyst Morningstar’s summary of City news in September was admirably brief. “Passive fund providers have competitively reduced charges and closed-end funds are on track for a record year,” Morningstar revealed.
What’s going on here? At first sight, those two themes are conflicting. You would expect a price war in the passive fund sector to boost sales (and the Investment Association’s figures suggest this is indeed what has happened). Almost all closed-end funds, meanwhile, are actively-managed – yet as Morningstar reports, the investment company sector is heading for a record year of sales.
However, it is possible to square this circle. The debate about passive versus active management is an old one, but in an era where index trackers are getting ever cheaper, it’s hardly surprising that investors and advisers are unwilling to pay significantly higher fees for actively-managed funds that they worry won’t beat the market in any case. Equally, however, where investors have confidence in the ability of an active fund to outperform, why wouldn’t they pay extra in order to secure those higher returns?
Enter the investment company sector, which boasts two advantages in this regards. First, closed-end funds have long been competitively priced, so that the charging differential between the typical investment company and a passive fund is not all that wide. And second, more significantly, investment companies have a strong record of outperforming the market.
The latest quarterly performance figures compiled by the investment company analyst Winterflood Investment Trusts provides some good examples of that outperformance. The third quarter of the year saw investment companies outperform the market as a whole for the fifth consecutive quarter, Winterflood reveals. Over the 12 months to the end of September, the investment company sector was up by 1.9 per cent, compared to a 2.9 per cent decline in the FTSE All-Share Index. And year-to-date, the sector is up 1.1 per cent against a 2.9 per cent fall for the All-Share.
Over the long term – which is the period that should really interest stock market investors – the record of investment companies is equally impressive. In the 17 sectors looked at by Winterflood, investment companies beat the index in 13 instances (they also outperformed open-ended funds in 13 cases).
Now, all of the caveats about past performance offering no guide to the future remain as relevant as ever. But based on that record, you can see why advisers and investors who do want active fund exposure are increasingly looking to investment companies as the place to get it.
There’s a bit more to it, of course. The other explanation for the strength of investment company sales this year is that the sector offers a very accessible way into alternative investment classes such as property, infrastructure and debt, where liquidity concerns make it difficult for open-ended funds to participate.
This is important given the increasing tendency of some investors and advisers to opt for a passive approach in the more mainstream parts of their portfolios, while looking to actively-managed exposure to specialist investments for diversification and additional performance.