The Bitcoin boom

Investment companies can be pleased with their end-of-term report: 2017 has proved to be yet another year in which closed-ended funds have outperformed the open-ended sector. Indeed, new research from the investment companies team at Winterflood suggests this has been a year in which that lead has been cemented.

Winterflood’s analysis focuses on 67 closed-ended and open-ended equity funds where performance comparisons are most appropriate, given that they’re run by the same investment manager and follow the same investment strategy. Over the 12 months to 30 November, 79 per cent of the investment companies in the comparison outperformed their open-ended counterparts.

That’s no flash in the pan. Over longer time periods, albeit with slightly smaller universes of funds to compare, investment companies also came out on top. Over three years to the end of November, 71 per cent of closed-ended funds did better; over five years the figure was 76 per cent. The average outperformance of closed-ended funds was 2 per cent over one year and 1 per cent a year over both three and five years, which adds up to pretty significant margins if sustained over time.

Some analysts had expected this gap to close in recent times. Historically, one major contributory factor for investment companies’ tendency to outperform has been their lower charges; in many ways it was a disadvantage for the sector not to be able to pay commissions to financial intermediaries, but this bar did at least give closed-ended funds an edge on cost. But since all commission payments were banned five years ago, open-ended fund charges have become much more competitive – one might have expected the performance gap to narrow accordingly.

The fact that this is not what has happened provides further support for the argument that the structural advantages of investment companies are the crucial determinants of their consistently superior performance.

“Open-ended funds can face regular or significant outflows, which can require a liquidity buffer, thereby creating cash drag, or may mean managers are forced to sell stocks at inopportune times; in contrast, managers of closed-ended funds do not face these constraints and can therefore take a truly long-term approach to investment, which should also help to reduce portfolio turnover and the associated trading costs,” says Winterflood.

“The fixed pool of capital also makes it easier for managers to invest in more illiquid stocks; in addition, investment trusts can use gearing, which will contribute to returns in rising markets.”

These arguments will be familiar to advisers who are long-time supporters of the investment company sector, but they’re worth stressing again to those intermediaries who still fret about perceptions of complexity. It’s also worth pointing out that the discount on which the average investment company’s shares trade relative to the value of its assets – often a worry for sceptical advisers – has fallen to a near all-time low of 2.4 per cent at the time of writing.

What will happen in 2018 if, as some market analysts fear, the bull run for equities runs out of steam? Well, the gearing employed by many investment companies – undoubtedly an important factor in their outperformance – would be a negative performance contributor during a period of falling markets, though there are steps funds can take to mitigate this risk. Discounts would be likely to widen again too, as investor sentiment deteriorated.

Still, for advisers and investors who want long-term exposure to equity markets, or other asset classes held by investment companies, irrespective of the short-term outlook, the same question remains: what’s the best way to secure that exposure? The case for closed-ended funds, on the basis of the latest data, looks as strong as ever.