Rules shakeup is set to level up the playing field for funds
OVER the last decade, investment trusts have outperformed open-ended funds in most regional sectors and benchmarks, with unit trusts underperforming across the board (see examples, above left). But despite this, many have been shepherded towards open-ended funds with some independent financial advisers (IFA) perhaps lured by attractive commissions. But according to Alan Brierley a director at Collins Stewart and a report published by them this week, the Retail Distribution Review (RDR), when it comes into force at the end of the year, has the potential to shake things up. When it comes into effect on 31 December, it will change the way that IFAs can structure their fees by eliminating commission. “Looking forward to next year, the leveling of the playing field represents a golden opportunity for the investment trust sector,” says Brierley. “Proven track records, lower total expense ratios, the ability to focus on managing money rather than be distracted by managing inflows/redemptions, the ability of income funds to use revenue reserves to smooth dividend payouts, the potential for net asset value (NAV) enhancements through gearing, buybacks and share issuance give the sector strong competitive advantages.” Brierley adds: “In addition, the valuation differential between open and many closed end funds compound these attractions.”
But how do the two structures compare? The absence of a limit on the number of shares that a fund can issue gives open-ended funds instant liquidity. They are often seen as the more flexible option – redemption requests are quickly processed and your holdings liquidated within 3-4 days. With closed-ended funds you cannot simply buy in as and when you wish. Behaving like a stock market flotation, closed-ended funds issue a fixed number of shares – traded on exchange. The opportunity to buy into closed ended funds at a discount is a big draw for investors – on issuance, market prices often fall below NAV. Investors take a punt that the gap across the discount and the NAV will close and move to a premium. However, this is of course not guaranteed: “Closed ended funds tend to be cheaper both in terms of initial and ongoing charges paid – theoretically therefore you can get access to the same managers for less money,” says Oliver Clarke-Williams, investment product consultant at FE Analytics. But he warns that an investor always needs to be aware of the discount to NAV. “Whereas with an open ended fund you are always paying what the fund is worth, with investment trusts you may end up paying more than it is worth because of the goodwill built into the price.”
BAILING OUT
And whereas in times of high market volatility investors can simply sell out of an open-ended fund, investors in a closed-ended fund are typically locked in for five years. According to Christian Parker, partner at law firm Paul Hastings: “Closed-end funds typically have one major advantage, namely that, in a panic where investors may be racing for the exit and invariably the worst time to sell, they will have no obligation to sell their underlying assets and so destroy value for those left behind.”
As the retail space shifts and with volatile times undoubtedly afoot, it is likely that we will once again see closed-end funds outperform.