Structurally secure

At first sight, three forthcoming investment company launches from Fundsmith, Mobius Capital Partners and Asset Value Investors look very different (though the first two, to be run by Terry Smith and Mark Mobius, do both have high profile names at the helm). The funds will invest in global equities, emerging markets and the Japanese market respectively.

Look more closely, however, and you’ll note that all three funds share a bias towards smaller companies. Fundsmith’s Smithson Investment Trust will target fast-growing businesses that are too small to hold in the company’s Fundsmith Equity fund. Asset Value Investors’ AVI Japan Opportunities Trust will focus on Japanese smaller companies. And the new Mobius vehicle will look for small and medium-sized companies in emerging markets – particularly those that reflect certain environmental, social and governance values.

There has been some comment this year on the slowdown in new issues in the investment company sector. In truth, this slowdown should have surprised no-one, given that new issues last year were at record levels and that so many analysts believe we are now in the dog days of the stock market’s extended bull run. Still, these new launches are a reminder of where the investment company sector so excels, wherever in the market cycle we may be.

That smaller company bias is part of the story. Small caps tend to be more volatile in the short term, even if they can deliver outperformance over longer periods, and can also be illiquid. It is much easier to manage both these characteristics in a closed-ended fund than through an open-ended structure, where investors unnerved by unexpected ups and downs can cause major problems by rushing for the exit and forcing the manager to sell out of a tightly-held stock.

Indeed, the nature of these funds more broadly is ideally suited to an investment company structure. In each case, the long-term promise of these funds is exciting, but there is also the potential for plenty of ups and downs along the way. Investors may need to be patient – but in an open-ended fund, the danger is that if too many investors aren’t prepared to be long-termist, they’ll undermine the position of those who do stick around.

In an investment company, the worst that will happen, should investors decide to leave, is that the shares will slip to an ever-wider discount to the value of the underlying assets. But for investors staying patient, this doesn’t matter – the assets remain intact and the discount will narrow once performance starts to attract investors back in.

By contrast, in an open-ended company, once the manager burns through their cash buffer – many that can’t be invested in the underlying asset class by the way – he or she must start selling assets. Those sales means investors remaining won’t get the benefit of long-term recovery. And the more illiquid the market or asset class, the more likely it is that the fund will have disposed of its assets at rock-bottom prices.

None of which is to say, of course, that these funds will perform well, let alone that advisers or investors should rush to buy – that’s a different conversation. However, these launches do remind us again of the value of the investment company structure in itself. Without it, innovation in fund management would be much harder