Investment company performance vs OEICs

Historically, investment companies have outperformed open-ended funds such as OEICs and unit trusts over the long term. For example, in the ten years to 30 September 2021, the average investment company returned 265%, while the average open-ended fund returned 70%.*

Analysis of investment companies with the same fund managers as OEICs or unit trusts has also shown significant outperformance for the investment companies over periods of at least five years.

However, investment companies will not always outperform open-ended funds. In particular, investment companies are expected to underperform open-ended funds when markets fall. This is because investment companies use gearing, which magnifies returns, and because investment company discounts tend to widen when markets are falling.

Why might investment companies outperform over the long term?

Apart from gearing, there are a number of other reasons investment companies may outperform similar open-ended funds over the long term. These are all related to their closed-ended structure:

  • Less cash drag. Unlike open-ended funds, investment companies do not need to keep a ‘buffer’ of cash to meet potential redemptions.
  • Less likely to grow to excessive size. Successful open-ended funds typically receive substantial inflows, which can hurt returns if fund managers are obliged to dilute their investment approach to suit the fund’s larger size. Investment companies do not have ‘inflows’, and may raise more money only if shareholders agree. This reduces the risk that the fund will grow to a size which is too large for the strategy to be run effectively.
  • Inclusion of illiquid assets. Academic research suggests that illiquid assets may outperform more liquid assets over the long term (a factor known as the liquidity premium). Open-ended funds are unwilling to hold illiquid assets because of the difficulty of selling them when investors want to redeem their units.
  • More exposure to smaller companies. For a similar reason, investment company managers are more likely to have higher exposure to smaller companies than their open-ended counterparts, who need to consider how easy it would be to liquidate their investments if investors in the fund wanted to redeem their units. Smaller companies tend to outperform large ones over the long term, as shown by many academic studies.
  • Better timing of investment decisions. Open-ended funds need to buy assets when investors buy units in the fund, and sell assets when investors want to redeem units. This can force a fund manager’s hand. The managers of closed-ended funds have much greater freedom in timing their buy/sell decisions and can take a long-term view.

* Source: AIC using Morningstar, based on share price total return.