Digging deeper into closed-ended funds

Digging deeper into closed-ended funds

Since the implementation of the RDR, closed-ended investment companies such as investment trusts and VCTs have seen an increase in the number of advisers trading their shares. Indeed the Association of Investment Companies (AIC) reported on 30 September 2015 that it had seen record adviser purchases of £260.8m in the second quarter of 2015, an increase of 112 per cent on the same period last year. There was also an increase in the number of adviser firms transacting this business.

So if you are new to the closed-ended world, or perhaps want a refresher, it is worth looking at the different statistics you will see compared to the information available for open-ended investment companies (Oeics).One important point worth noting is that some advisers incorrectly believe they need

to hold a securities qualification to advise on investment companies such as investment trusts and VCTs – they are, after all, listed securities –

Article continues after advert

but this is not the case because they are also collective investments and specifically listed as such alongside Oeics, allowing advisers to advise clients on them without the need for specific securities examinations.

NAV and share price returns

You will be used to, and will understand, the net asset value (Nav) – broadly the price at which investors will buy and sell open-ended funds – along with the bid/offer prices and spreads. This is underpinned by the fact the manager can create or cancel units/shares to accommodate transactions by investors in the fund.

Closed-ended funds, however, have a fixed number of shares in issue and so the managers can not create or cancel shares when investors want to trade them. When an investor buys investment trust shares, for example, they do not go to the manager to execute the transaction but instead buy them from one or more willing sellers in the marketplace. This means the underlying net asset value is unaltered by the transaction and the number of shares in issue remains unchanged; all that happens is that the ownership of some of the existing shares changes.

Consequently, the share price (the price at which the shares change hands) is not directly linked to the value of the underlying assets (the net asset value) and may be more or less than the nominally attaching Nav per share. This gives rise to either a discount (share price below Nav per share) or premium (share price above Nav per share) to the net asset value. By purchasing at a discount, an investor is thus able to acquire the fund’s underlying assets (and the income arising from them) for less than the price that it would cost to purchase them in the open market.

When looking at performance, both Nav past performance and share price past performance are available. So what is the difference? The Nav past performance is the performance of the underlying portfolio and so is comparable to the Nav performance of an open ended fund – it is a measure of the success of the manager’s investment strategy.

The share price performance on the other hand shows how the share price (the price at which the shares trade) has changed over time. When assessing the actual return a client has achieved on an investment trust holding, it is the share price performance that is more relevant because it is the share prices at which they bought and sold which determine the return.