David Prosser looks back at a “stellar year” for the investment company industry.
You might describe it as a tale of two fund structures. On the one hand, 2019 was something of an annus horribilis for the open-ended fund industry, from the collapse of Woodford Investment Management to the gating of a string of property funds. On the other, investment companies enjoyed a stellar year, posting robust returns and attracting significant inflows of new money.
No wonder the annual report on the latter sector published this week by Winterflood Investment Trusts was entitled “You’ve never had it so good”. As the Winterflood team points out, the sector delivered a 21.4% return over the year, ahead of the 19.2% gain from the FTSE All Share, and has now outperformed the market in seven out of the past 10 years. The sector’s share issuance hit a record high, even if IPO activity was slower, and the discount at which the typical investment company’s shares trade relative to the value of its underlying assets dropped to just 1.2%. That was down from 4.4% at the beginning of 2019.
What is driving this golden period for investment companies? Well, the extended bull run on global equity markets is clearly an important part of the explanation. With investment companies able to take on gearing, they are uniquely well-placed to capitalise on a rising market.
However, it would be wrong to characterise this story as a case of “a rising tide floating all boats”. In many regards, the success of investment companies over the last 12 months reflects substantive groundwork put in over a much longer period.
Not least, investment company boards have become significantly more interventionist, flexing their muscles on behalf of shareholders. It’s not only that boards are now far more likely to call underperforming managers to account, though this is undoubtedly the case, but also that many have approved tough discount control mechanisms. These prevent the industry slipping back on to the double-digit discounts that were once routine.
At the same time, investment companies appear to have discovered the value of giving the customer what they want. The industry has recognised the huge demand for income in this low-interest rate environment and developed fund structures accordingly, often exploiting the greater freedoms that investment companies have to organise themselves for yield generation. Plus there’s been a focus on innovation, with new fund launches in asset classes that were previously difficult to access for most retail investors
The sector has also worked much harder at engaging with the intermediary audience, recognising advisers as an under-exploited market for closed-ended funds. Efforts to build bridges with advisers are paying off, with purchases from intermediaries consistently breaking records; investment companies are no longer an afterthought for the majority of intermediaries considering how to achieve the asset allocation goals of their clients.
All in all, investment companies are entitled to give themselves a pat on the back – last year’s report card is just reward for a long period of hard work. But it would be wrong to slip into complacency in a marketplace that never stands still – the work must go on.
Cost, for example, will need to be an ongoing issue. Advisers and their clients are rightly asking far tougher questions about charges than ever before, with regulators also focused on this issue. Price competition from the open-ended sector, where funds have been cutting charges aggressively, will continue.
Then there’s the discount question. At the current rating, Winterflood points out that “there is a downside risk to ratings, particularly in the event of deteriorating market conditions”. Boards must be careful not to let any derating get out of hand, focusing on both supply – through share buybacks, for example – and demand, where Winterflood thinks the allure to investors of income can provide some protection.
The work continues, in other words. Eight years after the retail distribution review, the regulatory reforms that gave investment companies the chance to compete on a level playing field with other fund structures, the sector can be pleased that it has grasped the opportunity. But it will need to keep proving itself.