As the FT noted last week, this month marks the 100th anniversary of the creation of the mutual fund. Unlike the investment trust, the fund was a US invention. Over on those shores, however, its modern-day prominence is being squeezed by a range of factors, not least the greater tax-efficiency of exchange traded funds (ETFs).
ETFs don’t enjoy the same kind of tax breaks in the UK, which is one reason why the open-ended fund has retained its top-of-the-pile status over here. There are plenty of others, too.
Consider the big shift in the investment world over the past 20 years – passive investments’ surge in popularity. In the UK, the rise of passives has meant index funds have come to the fore more so than exchange-traded equivalents. The iShares UK Equity Index fund, for instance, has over £10bn in assets. The same provider’s MSCI UK ETF holds less than £100mn. For years, many platforms simply didn’t offer ETFs, and that gave index funds a crucial head start.
This is also why open-ended funds historically had an advantage over investment trusts: for years, accessing trusts on platforms was relatively difficult; many providers simply didn’t offer them, or at least not in any great shape or size.
While this issue has largely been resolved, there are other barriers to trust take-up. Even now, professional investors’ preference for funds rather than trusts has contributed to many of the latter languishing on sizeable discounts to net asset value, and in some cases being forced to seek a merge or simply wind-up as a result of their lack of assets.
Conversely, the size of the ETF market means the relative struggles of many of the products available to UK investors have gone unnoticed. Hundreds if not thousands of exchange traded vehicles are on offer, but there is a long tail of products whose size must put them at risk of closure before too long. It is often those doing something different that are most at risk.
Outside of gold and commodity products, it’s ‘thematic’ ETFs, focusing on a particular investment trend, that are most likely to offer something different from the kind of investment available in open-ended funds. But by definition, these products are targeting specific investment niches, and are therefore often destined to attract only a relatively small amount of assets.
Accessing these niche ETFs is also sometimes tough: the range of products on offer on some platforms is still relatively low. Many platforms’ back-end systems are still relatively clunky, and not as adept at trading these vehicles as they should be. And we shouldn’t forget another impediment for users: dealing costs for ETFs, shares or investment trusts are still relatively high in most cases, whereas for funds there’s often no charge at all. For those who aren’t infrequent traders, that can more than offset the caps on annual fees that some platforms implement for exchange-traded instruments.
All of this goes to show why platforms’ most recommended products, which we highlight this week in our cover feature, are almost always open-ended funds rather than ETFs or investment trusts. This isn’t to criticise funds as an investment vehicle: they are as good as any other. But the reasons for their pre-eminence are worth highlighting.
Could any of this change in future? For ETFs, the clarification of rules around fractional trading in Isas could provide a minor filip, particularly when you consider that younger investors are more likely to hold ETFs than their older peers – partly because many newer platforms focus solely on this type of vehicle. And there’s clearly an argument for buying investment trusts over funds at the moment given the big discounts on which many of the former still trade.
Yet if these shifts happen, they would still be relatively minor in the grand scheme of things. Open-ended funds are still a force to be reckoned with in the UK, and will remain so for the foreseeable future. For our part, we’ll continue to highlight investment opportunities from across the spectrum, be it via our regular investment trust coverage, cover features like this week’s, or our annual Top 50 ETFs and Top 50 Funds rundowns.
