Same old story

David Prosser dispels old myths about the investment company industry.

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Some battles are never won. Almost seven years after the Retail Distribution Review levelled the playing field in the collective investment fund sector, investment companies are resurgent, racking up record sales, converting financial advisers to their cause and attracting a whole new shareholder base of retail investors. Yet we still hear the same old hoary snipes about the sector.

It’s easy to get tired of making the same points over and again. But reflecting on an opinion column published in The Spectator this week by one of the UK’s most widely-respected (quite deservedly so) financial commentators, it’s clear that these arguments still need driving home.

Ironically, the column was reflecting on lessons from the Woodford funds saga, which one might have expected to play in the favour of investment companies. After all, this is a story about how the open-ended fund structure is not fit for purpose when it comes to investing in certain assets; in contrast, the investment company does not suffer the same problems.

While not disputing this point, the article honed in on how investment company shares trade at a premium or a discount to the value of the fund’s assets. This feature, the columnist concluded, is “too damaging” to financial health.

Back to basics, then. The most obvious rebuttal of this conclusion is that whatever you think about the merits of different types of fund structure, the figures do not lie. And every single comparison of comparable investment company and open-ended fund performance suggests the former tend to outperform the latter over medium to long-term periods. There’s only one loser in such exercises and it isn’t the investment company sector.

Why is this? Well, there are myriad reasons why investment companies are able to over-achieve. They’re very often cheaper, which is a big advantage. They can employ gearing, which boosts returns when asset prices are rising. Their managers are free to concentrate on asset allocation and stock selection without having to worry about inflows and outflows of investors’ funds. These managers, by the way, tend to stay in post for far longer. The independent board, there to represent investors’ interests, is another plus point.

Yes, it is true that the share price of an investment company rarely reflects accurately the value of the fund’s assets. Sometimes the fund is over-valued – trading at a premium – and sometimes the opposite is true, when the shares are on a discount.

But is this really such a problem, in the context of long-term outperformance? And in any case, it’s possible to think about premiums and discounts in a different way too. Effectively, they provide a pressure release valve – when demand and supply for an investment company get out of kilter, the share price can move without there being any impact on the underlying portfolio. Open-ended funds don’t have that luxury, which is often problematic and in extreme circumstances – back to Woodford – can prove disastrous.

Add in some other arguments – the value of investment companies and their dividend reserves to income seekers, for example, and the access to new asset classes the sector can offer – and you begin to understand why the industry has been rediscovered in recent times. Now, that is, financial advisers no longer receive sales commissions when clients buy open-ended funds.

Still, it’s clear that not everyone gets it, even today. We’ll just have to keep banging the drum.