Hello, and welcome to the Morningstar series, "Ask the Expert."
I'm Emma Wall and I'm joined today by two Morningstar fund analysts to discuss why a
similar open and closed-end fund have different fund ratings.
Hi, guys.
Good morning.
So, first, I'd like to go to you Sam and ask what are the five factors that Morningstar
fund analysts consider when rating a fund?
So, we call it the 5 P methodology.
The first pillar is People.
So, we look at who is managing the fund and the general resources backing them.
Second is Process.
So, we look at how they go about finding investments and ongoing monitoring.
Performance would be the third.
Obviously, that's a factor that we look to assess and whether the fund performs as we
expect in different market environments.
Parent is the fourth.
So, an assessment of the company behind the offering.
And finally, Price.
How much it costs investors to invest in that fund.
Before we look at a specific example of a fund where the open and closed-end ratings
differ, I thought you, Dave, could just run us through some of the unique properties that
a closed-end fund has, the tools at the fund manager's disposal that they don't have with
an open-ended fund?
Indeed.
Although, not all fund managers use the tools that are available to them.
But theoretically, the key advantage of a closed-ended fund is that it's not subject
to inflows and outflows due to investor demand.
And so, therefore, it makes particular sense to house more illiquid assets within a closed-ended
structure, i.e., if an underlying asset is illiquid, it means it can't be bought and
sold readily.
And so, within a closed-ended structure, the fund manager is not able – does not have
to buy and sell an illiquid asset if he is subject to demand for that particular fund.
The second key difference is the use of gearing.
And so, borrowing money to make investments into the fund, which can increase risk, but
it can also increase return also.
Having a look at some funds that are run by the same manager with similar portfolios but
has a quite different outcome.
Some very high-profile examples are things like Mark Barnett's Edinburgh Trust, Invesco
Perpetual High Income and Income, the funds that were previously run by Neil Woodford.
Looking at an example where the open and closed-end funds have different fund ratings, we're looking
here today at Standard Life UK Smaller Companies, I'll come to you, Sam, first to talk about
the things that you both like as the open and closed-end fund analysts on these funds.
Yeah, sure.
So, going back to the People pillar, Harry Nimmo is one of the most experienced UK Smaller
Companies managers in the industry and he has built a strong track record over his tenure
on this fund from January '97.
And throughout that time there has been a consistent application of the investment process
which involves a proprietary quantitative screen to help Nimmo and the team focus down
on the most interesting ideas to look at.
So, those are the key areas really, his experience and the stability within the process.
And Dave, how do you rate this, the closed-end fund version of this portfolio?
We rate both of the funds very highly.
We've given the closed-ended version of the strategy the highest rating that we can give
for a Morningstar Analyst Rating, that is Gold.
And principally, it's to do with the implementation of the process.
As Sam has explained, much of the inputs into strategy is the same, it's the same people
making the decisions, it's the same process.
But we feel that the closed-ended structure allows Harry to implement his process in a
much better way.
He is not subject to inflows and outflows.
He can take a longer-term position.
Or he can be more flexible if he wishes to be so.
He can also invest into slightly smaller companies, which tend to be a little bit more illiquid
and he can also invest more into AIM-listed companies, which again, can be illiquid as
well.
So, it feels to me as that you get the purest form of Harry Nimmo within the investment
company.
That's not to say that the open-end fund doesn't have a very positive rating though, does it,
Sam?
That's right.
The open-ended fund is rated Silver and that reflects our still very high conviction in
that product despite perhaps some of the smaller advantages that the investment trust structure
does have here.
As we've discussed, it's still the same manager applying the same process with a very strong
long-term track record.
Thank you very much both.
This is Emma Wall for Morningstar.
Thank you for watching.