The barriers to financial advisers using investment companies have demonstrable flaws says David Prosser.
The relationship between financial advisers and the investment company industry has come a long way over the past five years. Where once they barely spoke, with investment companies unable to pay the commissions their open-ended counterparts offered, the banning of such payments has triggered a rapprochement. The recent travails of the open-ended Woodford Equity Income fund, moreover, have underlined the advantages of a closed-ended fund structure.
Still, the course of true love rarely runs smooth – and there are still advisers out there who aren’t sure they want to commit. Comments made by one senior investment manager at a leading wealth management firm this week offered a good example. He very much liked investment companies, he explained, but feared they weren’t suitable candidates for brokers’ buy lists.
The wealth manager’s argument was partly based on a fear that if too many people bought into an investment company at once it could distort valuations, with limited liquidity sending the fund’s shares soaring to a premium. He also warned many retail investors didn’t fully understand investment companies – in particular that they take on gearing which can magnify volatility.
Let’s deal with the second point first. Yes, some investment companies take on gearing, though in the vast majority of cases, it’s pretty modest. And yes, gearing does exaggerate returns in good times and bad, for better or for worse. But the net effect of gearing over time has been to help investment companies outperform their closed-ended counterparts, because over time markets have tended to rise. That’s not so difficult to get your head around. And as for lack of understanding, try asking retail investors if they have always appreciated that to hold illiquid assets in an open-ended portfolio is to risk being denied access to your money for months on end.
What about the buy list problem? In fact, this is a repeat of a longstanding attack line against investment companies – that they are too small to cope with the walls of money that large financial advisers and wealth managers could send their way. But while this may be true in the case of the smaller funds in the industry, many larger investment companies are highly liquid and the market has been coping with considerable flows of cash in and out of them for many years.
Besides, it is a clear advantage that the structure of an investment company protects investors from liquidity issues. When the fund feels the strain, it is the shares that move, not the value of the underlying portfolio. But over time, discounts and premiums return to more normal levels as demand and supply level out. Investors committing to a fund for the medium to longer term – as all investors should be – will be unaffected.
Are we really suggesting that when investors ask about the best funds in which to place their money, they should be given only a partial view – that they shouldn’t be told about low-charging, well-managed investment companies with a long history of outperforming rival funds? That seems perverse.
Let’s be fair. Financial advisers’ engagement with the investment company sector has improved out of all recognition, to the benefit of their clients. But we are still seeing some of the old criticisms rehashed despite their demonstrable flaws. Let’s keep talking.