InvestmentsApr 5 2017

Headwinds weigh on equity-focused investment trusts

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Headwinds weigh on equity-focused investment trusts

Closed-ended funds that invest primarily in equities have struggled to keep up with the scale of their alternative asset-focused peers as headwinds continue to weigh on the sector.

Lower ongoing charges for open-ended funds, the growing popularity of passive funds, and increasing demand for alternative assets as a means of adding diversity to a portfolio have caused on drag on the equity investment company sector.

Net issuance of equity investment trusts over the past five years has totalled just £1bn, with half of new money raised coming from ten investment companies.

This figure is further skewed by Neil Woodford’s closed-ended fund the £753m Woodford Patient Capital, which has a high allocation to unlisted equities.

By comparison, a net £17.7bn has been raised for alternative investment companies over the same five year period as investors look to add a more diverse set of assets to their portfolios.

Alan Brierley, director of investment companies research at Canaccord Genuity, said that a market slump could weed out those investment trusts that are most susceptible to recent headwinds, and added that it is important to look for trusts with boards that are actively addressing such issues.

“Given this increasingly competitive backdrop, and with markets so far into uncharted waters, the next part of the cycle is likely to expose those companies whose performance has been more dependent on beta, and these are likely to become marginalised.

“We look for boards to take decisive action to address companies that are no longer relevant, competitive, or which lack critical mass.”

Mr Brierley added that a cost analysis of closed-ended funds should not focus solely on the immediate peers, and that “greater conviction, innovation and proactivity” would be welcomed to help generate sustainable demand.

Annabel Brodie-Smith, communications director at the Association of Investment Companies (AIC), said the investment company industry is in “good health”, as industry assets have soared to an all-time high of £163bn.

Performance among investment companies has not yet waivered, with the average closed-ended fund delivering 112 per cent over the last 10 years with an average discount of 3 per cent, close to a 10 year low.

Ms Brodie-Smith added that investor interest in alternative assets has acted as a positive for the investment company industry as a whole.

“Demand for alternatives has been a boost for investment companies, with alternatives now making up 40 per cent of the industry and well over a third of the sector have reduced their fees to benefit shareholders since 2012.

“Of course, there are always concerns but we need to keep them in perspective.”

A long running bull market has made passive funds increasingly difficult for active managers of both open and closed-ended funds to beat, causing swathes of investors to pile into funds that track an index.

A recent report from Canaccord Genuity highlighted how the Retail Distribution Review (RDR) acted as a catalyst for lower fund charges in the open-ended industry, which has reduced the impact of a traditional advantage of equity investment companies, while the growth of passives has added further competition to the market.

Charles Cade, head of investment companies research at Numis Securities, said that investment companies with an equity mandate have been reducing fees and removing performance fees in recent years in order to remain competitive in the post-RDR environment, but added that they ultimately need to deliver strong performance and a consistent yield to prove their worth to investors.

“They need to be actively managed in order to justify fees versus passives. Increasingly, investment companies are managed on an unconstrained basis which the managers believe will offer superior long term performance than an index hugging approach,” Mr Cade said.

Sarah Godfrey, director on investment companies at Edison, said that passive funds pose a unique risk of their own, and although they are often cheaper than active fees they still do carry a cost.

Investors that choose a passive fund risk buying it at the wrong time when the market nears its peak and a crash ensues, or picking the wrong index or market to track, she said.

“As far as the popularity of passives goes, it’s something that has historically tended to happen in a long period of rising markets. People begin to see equities as a one-way bet and therefore start to focus on [factors such as] costs as a differentiator,” Ms Godfrey said.

But even the cheapest passive fund is not free, and so investors in passives guarantee that they will underperform whatever index their fund tracks.

julia.faurschou@ft.com