Open or closed?

The age-old argument about whether open-ended funds or investment companies offer the better performance continues to rage. The answer has traditionally been the latter, thanks to a combination of lower cost, structural advantages and features such as gearing, which can enhance returns. But open-ended fund supporters point out that at least some of these benefits have been eroded in recent times.

In particular, investment companies no longer automatically come out on top when it comes to pricing. Open-ended funds have been able to cut their charges since the retail distribution review of five years ago outlawed the commission payments that these funds typically levied. We’ve seen something of a price war as a result – a recent study from wealth manager Tilney looked at 47 pairs of similar open-ended funds and investment companies, and concluded that the latter were cheaper in around half the examples studied.

Tilney’s analysis is a reminder that while it’s usually difficult to settle arguments about the merits of competing investments, because like-for-like comparisons aren’t straightforward to find, that isn’t the case here. There are many examples of fund management firms which maintain both open-ended funds and investment companies in the same sectors, run by the same manager and invested in very similar portfolios. These pairs give us a control mechanism for comparing performance.

The latest attempt to do so is published in the August issue of Money Observer magazine, which looked at seven pairs of funds with exposure to a range of international markets. Investment company fans will be pleased to hear that the magazine rated their vehicles as the winners in five out of the seven cases studied, and scored the contest as a draw in the other two cases.

This is by no means definitive, but it does provide further support for those who argue that cost isn’t the only important factor to consider in this argument – or even the most important one.

Over time, the impact of gearing is clearly going to be significant. Investment companies get a boost from holding gearing when markets are rising, but suffer during down periods; still, assuming you buy the idea that stock markets outperform over the long run, which you presumably do if you’re invested in equities, gearing should be more help than hindrance.

Similarly, the advantages of running a closed-ended investment company are often overlooked but can be significant. Just ask any manager in the open-ended property fund sector, which last year found itself besieged by investors rushing for the exit in the wake of the UK’s vote to leave the European Union. Managers of closed-ended property companies had no such distractions.

The bottom line is that comparing the two types of fund is something of a facile exercise – in the end, advisers and investors must choose the best tool for the job they need doing. Moreover, in some markets, the distinction between open-ended and closed-ended is more significant than in others; the property example is one such case, but similar lessons apply to any other illiquid asset class.

Nevertheless, Money Observer’s latest comparison makes for interesting reading. On the whole, investment companies appear to be maintaining their edge.