Keiron Root’s monthly review of developments in the investment fund markets.

The Investment Management Association (IMA) has been reviewing the impact of the credit crunch on the open-ended fund sector, and interesting reading it makes. The Association reports that ‘not only have investors suffered losses across all major asset classes but funds have also been subject to stress testing of their structures and the regulation governing them.’

In general terms, the IMA’s report gave a clean bill of health to the open-ended fund structure, with only seven out of a total of 2,350 funds having to suspend dealings during the 15-month period to the end of March 2009, and these were mainly specialist funds aimed at professional investors rather than mass market retail offerings. This is testimony to the liquidity inherent in both the structures of OEICs and unit trusts and of the assets in which the bulk of them invest.

While most investors will not generally concern themselves with the details of how investment funds are constructed, there are a couple of key points that help to explain why UK authorised investment funds have proved so robust during the current crisis.

Safe custody
In particular, the assets of such funds, whether structured as an OEIC or a unit trust, are held separately from those of the management company running the portfolio, so if the fund manager gets into difficulty, the assets of the investors in the fund are ring fenced. The depositary or custodian who holds these funds must be completely independent of the fund management company and is itself subject to scrutiny by the financial regulators. The fund managers are also required to maintain a diversified portfolio, within the context of the fund’s objectives, manage the liquidity of the funds to ensure that investors can buy or sell when they want to, and be transparent with regard to performance figures and charges.

Julie Patterson, director of authorised funds and tax at the IMA, observes that ‘Given the unprecedented events of the past two years, the industry reviewed the impact on authorised funds and took on board any lessons that arose. It is encouraging that the regulatory regime and industry practice have ensured that authorised funds have stood up well in the current crisis. As a result of this due diligence exercise, we shall be taking forward a small number of recommendations where it is thought that rules could usefully be clarified or industry practice more fully articulated, in order to strengthen the regime further.’


Sound stewardship
The probity of the fund management sector has also been highlighted in another direction recently, with the 25th anniversary of the first ethical fund in the UK. Originally launched in 1984 as the Friends Provident Stewardship Fund, to mark the retirement of the last Quaker member of the Friends Provident board, the fund now comes under the branding of the insurer’s soon to be de-merged fund management arm, F&C Management.

Karina Litvack, head of governance and sustainable investment (GSI) at F&C, points
out that ‘It is easy to forget how far-sighted the architects of Stewardship were back in 1984. Many observers were sceptical at the time, and no-one could have predicted that this fund was going to end up being such a big influence on investors’ behaviour in the years to follow. Over the past two decades, Stewardship, and ethical investment in general, have evolved into the idea that, as investors, we have leverage and the ability to drive behavioural change in companies. The new vision of ethical investment goes beyond the ethical screening of companies and into shareholder engagement and being part of positive change.’

She adds, ‘Stewardship, and the wider ethical investment movement, have always been focused on the non-traditional drivers of social, economic and environmental performance that were historically disregarded by conventional fund managers. Ethical investors always argued that these non-traditional performance drivers were important and that companies needed to be mindful of them. That rings especially true today, given some of the governance failures exposed by the recent financial crisis, and more and more mainstream investors are waking up to the need to become more active shareholders.’

Growing interest
This argument is borne out by a piece of market research conducted by The Co-operative Investments, which suggests that there is a steady increase in the number of people who want to invest along ethical lines.

Zack Hocking, head of investments at The Co-operative Investments, reveals that ‘Although ethical funds currently represent just one per cent of overall UK funds under management, our research shows that 18 per cent more people intend to invest ethically this year. The Co-operative Investment’s own ethical fund, Sustainable Leaders Trust, has seen an almost identical hike in unit growth throughout 2008 of 16 per cent, and this has continued during 2009.’

He adds, ‘The financial crisis appears to have encouraged investors to think not only about how much money they make, but importantly, how it is made. The focus of ethical funds to seek out stocks with responsible and sustainable business models has made them an increasingly attractive proposition to investors. Many ethical funds have now proven that they can deliver performance in line with the very best unit trusts in the market, while helping to bring about positive change in society.’

Still emerging
Another significant fund anniversary, and a further example of how investment markets have changed and developed over the past quarter of a century, this time in the closed-ended sector, came at the beginning of June, when the Templeton Emerging Markets Investment Trust (TEMIT) notched up its first 20 years. Dr Mark Mobius, manager of the TEMIT portfolio, observed that ‘It has been a remarkable journey for us as well as our investors. Over the past 20 years, the creation of new equity markets, particularly in those countries transforming themselves from communist and socialist economies to capitalist free-markets, has been amazing. We have seen many changes and major developments such as an ongoing progression in investors’ attitude towards emerging markets investing and the opening up of markets previously not accessible by foreign investors, such as Brazil, Russia, China, Turkey and India, which moulded this truly exciting asset class.’

Dr Mobius points out that, when the fund was launched, there were only five markets it could realistically invest in – Mexico and four in Asia – and none of the current titans of the BRIC grouping were on that list. By contrast, his team at Franklin Templeton are now running ‘frontier markets’ funds as well as ‘emerging markets portfolios’ to differentiate the newly emerging economies from the more established ones that are still regarded as ‘emerging’.

The growth of interest in emerging markets funds is an indication of the increasing willingness of investors to broaden their horizons and seek to diversify their portfolios into new markets and asset classes. And given the prominence of currency movements as a factor in the recent volatility, it is perhaps not surprising that Schroders has launched a currency fund as part of its International Selection Fund (ISF) offshore range, described by its manager as a ‘World Cash Fund’.

As Robin Stoakley, Schroders’ head of UK retail, points out, ‘Many investors hold assets in cash deposits but, with interest rates as low as they’ve ever been, deposits are not an attractive option. Moreover, with inflation expected to rise again in the future, the value of those deposits risks being steadily eroded over time. So Schroders wants to offer clients an alternative to cash deposits and government bonds that can deliver a higher yield, the potential for capital gains and, most importantly, help them to preserve their global purchasing power.’