Survival of the fittest

What happens when investment funds lose their way or slip from relevancy? In the open-ended fund sector, the short answer is not a lot. The UK is home to hundreds – if not thousands – of funds launched many years ago that are underperforming or have a value proposition no longer fit for purpose. Some savers have withdrawn their money, but others remain invested, whether through apathy or ignorance, with managers continue to earn chunky revenues from fees.

The investment companies sector, by contrast, is characterised by a much greater level of ruthlessness. Research published recently by the analyst Numis found that of 326 funds launched in the first decade of this century, only 54 have survived in their original format. Getting on for a quarter of the investment companies launched between 2010 and 2020 have already suffered a similar fate.

This challenging survival rate is a consequence of the inherent difference between open-ended funds and investment companies. The former are products, marketed by fund management companies and left on the market for as long as they continue to generate profits for their providers. The latter are companies in their own right, owned by their shareholders and managed by independent boards with fiduciary responsibilities to those shareholders.

When the going gets tough at an investment company, the board’s job is to start asking difficult questions. And if the directors don’t step up, they can expect a hard time from shareholders. The hardest question of the lot, of course, is whether the fund should continue to trade in its current form – or even at all. If in doubt, shareholders may be given a vote on whether to wind up the fund. And frequently, over the past 20 years, the results of such votes have been yes. Hence the low survival rate.

For the fund managers appointed to run investment companies, such an outcome is not a happy one. It is a public failure and it means saying goodbye to valuable fee income. Investors and advisers also have every right to be disappointed, having put their money into a fund that hasn’t delivered what they hoped for.

Nevertheless, this is a healthy cycle. At an industry level, it means the investment companies sector does not become bloated with funds that aren’t up to scratch. For investors, meanwhile, the wind-up of a fund provides a way out of a problematic situation; there are often several options to choose from, including the return of investors’ money at the value of the underlying assets or the opportunity to move into a more attractive fund.

Numis suggests that the Covid-19 pandemic could presage a significant shake-out of investment companies, with a flurry of closures of funds about which there have been doubts for some time. Small funds and those lagging in the performance tables may be particularly at risk. A similar cull took place in the wake of the global financial crisis in 2008 and 2009, the analyst points out.

Time will tell. Still, if we do see the number of funds fall sharply over the next year or so, this should not be seen as a setback for the investment companies sector. What we will actually be seeing is independent boards doing their jobs properly, holding managers to account and ensuring that shareholders aren’t stuck with irrelevant or poor value funds. Such processes are tough for the managers, of course, but to the benefit of investors.