The Association of Investment Companies (AIC) has hosted a panel discussion with Alan Brierley, Head of Research at Canaccord Genuity and Simon Elliott, Head of Research at Winterflood Securities, on the long-term performance of investment companies in comparison to open-ended funds. Why have investment companies tended to outperform comparable open-ended funds over the long-term? What are the reasons for this outperformance, and are some of these reasons still likely to be valid going forward?
The discussion centres around Canaccord Genuity’s latest quarterly research for the AIC comparing the performance of the open and closed-ended sectors (see page 3 to view the comparative performance figures). The latest research shows investment companies outperformed comparable open-ended funds in 12 out of 15 sectors over ten years, 14 out of 15 sectors over five years, and 11 out of 15 sectors over one year.
Significant outperformance over the longer-term
Commenting on the research, Alan Brierley, Head of Research, Canaccord Genuity said: “The message is simple: investment companies have outperformed open-ended funds and benchmarks over one year, five years and ten years, and the outperformance over the longer period is quite significant. Earlier this year, I looked at twenty investment managers who manage open and closed-ended vehicles with very similar objectives. The investment company outperformed the open-ended fund in every single occasion and the average outperformance was 3%, annualised over five years.”
Why have investment companies tended to outperform over the longer-term?
Simon Elliott, Head of Research at Winterflood Securities, confirmed that his own research had drawn similar conclusions. In terms of why, Simon Elliott commented: “There is no one answer, but four key factors that we would point to. Firstly, discounts have tightened over the last ten years, a trend we have seen across the sector. Gearing has also been a factor. Investment companies can use gearing to enhance returns and in positive market conditions this has been a benefit, as have lower costs. Finally, an investment company manager has an advantage in managing a closed-ended portfolio as it encourages long-term decision making.” Simon Elliott explained that investment company managers do not have to hold cash to meet redemptions, and can therefore choose to be fully invested, which can lead to longer-term outperformance.
Can this outperformance continue?
Investment companies tend to outperform over the longer-term, but investors may well experience a bumpier ride along the way, due to the impact of gearing and changes to discounts and premiums.
Picking up on this theme, Alan Brierley, Head of Research, Canaccord Genuity said: “Markets have gone up almost in a straight line for five and a half years and it begs some obvious questions. Gearing will be a drag [on performance] on the downside and discounts could widen if we enter a more challenging period.”
Alan Brierley believed there was often too much emphasis on discounts: “The message when choosing an investment should not be whether it is trading on a 5% discount or a 7% discount, discounts should not be a key driver: [investors] should identify quality and put it in the bottom drawer. Buy it and hold it for the long term.”
Will charges coming down in the open-ended sector eliminate some of the investment company sectors outperformance going forward?
Simon Elliott, Head of Research, Winterflood Securities said: “Investment company boards have been sitting down with managers and pushing for lower fees. Since the start of 2013, 20% of the investment company universe has seen a change to their management fee arrangements.”
Annabel Brodie-Smith, Communications Director, AIC, closed the discussion by adding: “The research demonstrates that investment companies can perform strongly over the long-term but can suffer short-term periods of volatility and need to be part of a balanced portfolio. For investors who would like to find out more about investment companies and whether they should be part of their pension, please visit our website, www.theaic.co.uk. Those unsure should consult a financial adviser.”
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