Closed-ended investment Companies

Investment companies (also known as investment trusts) have been part of the listed company firmament for almost two centuries.  At the outset, they provided access for those investors of modest means to professional portfolio management, a diversified portfolio and economies of scale in the costs of investment made and managed – including exposure to developing markets, which in the nineteenth century included US.  The same central rationale underpins these vehicles in the twenty first century, although institutional investors, wealth managers and private investors are all invested in them to varying degrees. Using the industry body, AIC (Association of Investment Companies), statistics at at @ there are some @ investment companies, with gross assets of £@ million, split between @ sectors.

Since the advent of open-ended investment funds, unit trusts, in the 1930s, the open-ended sector has grown in size, dwarfing the closed-ended company sector (The representative body of the open-ended sector, The IA, estimates assets of £@ billion as at @). As individuals have become increasingly responsible for their own financial well-being the use and population of funds has grown exponentially, whether it be pension funds (managed or self-invested), limited partnerships (for private equity and other more illiquid asset classes), open or closed-ended funds or other pooled investment vehicles, and the range of investment objectives they invest has proliferated too.  There are some defining characteristics for pooled vehicles, which will vary according to the type of vehicle:

• Investment objective and policy (which can vary from absolute to relative return objectives over any number of asset classes and geographies and can vary between active stock selection and passive stock selection, the latter tracking a specific benchmark);
• Initial costs associated with making an investment in the fund;
• Realisability of the assets in the investment pool;
• Redemption or trading in the secondary market of an investor’s interest in the fund and costs associated with the sale of interest;
• Costs of managing the fund, including all the governance and administration costs;
• Tax status (capital gains and receipt of income) of the pool’s portfolio and for investors’ interests in the fund;
• How the performance of the fund is measured, compared and contrasted; and
• How the fund is governed.

Closed-ended investment companies whose shares are traded on recognized exchanges can be amongst the more complex funds, but are also amongst the most regulated and are treated, along with commercial and industrial companies whose shares are listed and traded, as subject to companies acts and listing rule restrictions given the open nature on which investors can invest in the companies through the stockmarket.  Closed-ended investment companies should also theoretically be able to invest in asset classes which are relatively illiquid, unlike open ended investment companies who do not have permanent capital; can borrow to accentuate returns for shareholders (positively when the cost of servicing the debt is lower than the returns and negatively when the converse is true); can build up reserves to help smooth dividend distribution; have independent governance in place which puts the fund under close scrutiny – but at an additional cost; and can structure the equity capital to deliver returns in different ways (for example capital or income only or at a predetermined level); and the price at which the shares in the company trade can either be at a premium or discount to the prevailing net asset value.  The last point is also one of the perceived disadvantages of a closed-ended fund, namely that in buying at a premium the shares are expensive and selling at a discount to net asset value the shares are ‘too cheap’ – depending of course on the extent of the discount, which is more typical, or premium and how volatile the share price is around net asset value.

I have spent almost thirty years advising boards and management groups on investment company issues and transactions.  This career has meant that I become intimately involved in all the technical corporate finance issues connected to a company but because a fund consists of a portfolio of underlying investments I do not need to be expert in what the company does, as I would if advising a commercial or industrial concern.  It has also given me some understanding of why investors buy and sell investment companies, what attracts them to different types of investment objectives and structures and what triggers the sale of their interest in the secondary market or pressure to redeem their interest by another means.

In the most recent part of my career, I have been appointed as a non-executive director of five investment companies, all doing different things and all managed by different investment groups. The investment objectives policies vary from investing in UK commercial property, to venture capital, to Continental European listed equities, to UK listed income stocks and bonds and in the fifth case an absolute return vehicle that is protective of capital invested rather than competing against relative returns. I have been very fortunate, as this spread of activities gives me a continued involvement in the closed-ended sector and another perspective from having been an accountant, corporate finance adviser, broke to and investor in companies in the sector.  I would like to be able to continue to contribute to the sector and from time to time I am asked for my consultancy advice, particularly on more complicated situations. One of the aims on this website is to return some of my knowledge of the sector to the sector for those who might find it helpful.  This does not constitute financial advice any more than reading a text book on a subject. If decisions are being taken then formal advice should be sought not least as circumstances change and I could not pretend that all that I write is correct, despite my reasonable efforts to ensure its accuracy.  Things change, particularly on matters of law and taxation, but some things don’t change very much – including the reasons investors turn to closed-ended funds for investment exposure and what they hope to get out of them.