Active fund managers are sometimes described as rock stars of the City – they command astronomical wages, attract legions of devoted fans and enjoy an almost-mythical status when they’re on a roll.
They have massive control over our collective finances. If you’ve ever thought about investing some of your money, chances are that you’re either considered using a fund manager to take care of business or you’ve gone ahead and trusted some of the 25,000 active managers out there in the UK to make your money grow. I say “some” because the first golden rule of investment is diversification and it is to be hoped that investors are spreading their cash over several active funds to reduce and optimise investment growth.
Sadly, there is evidence that these rock stars of the City might not be any better in the long-term than simpler “passive” funds – which certainly cost a lot less. Now, the asset management industry, which oversees nearly £7 trillion of our money in pensions and investments, has been put on notice by the Financial Conduct Authority about excessive profit margins, murky charges and weak price competition.
Active managers have long justified high investment charges of over 1 per cent, usually disguised through various fees, by promising to beat the market. They cost substantially more than so-called “passive” funds, which simply track an index like the FTSE 100 and may charge as little as 0.1 per cent.
The FCA found that many active managers aren’t performing well enough to soften the blow of steep fees, ultimately shrinking the long-term returns that investors could be getting.
According to an interim report by the regulator, active funds have remained stubbornly expensive over the last decade, refusing to discount for new customers, even as the cost of passive investing was falling.
Instead, the FCA described a practice of price clustering, with managers sticking to fees of 0.75 or 1 per cent even as the size of their funds grew – suggesting that they fail to pass on economies of scale to investors.
Active managers are also too vague about their investment objectives and don’t allow for investors to measure their performance against a suitable benchmark. The report stated: “Investors may continue to invest in expensive actively managed funds which mirror the performance of the market because fund managers do not adequately explain the fund’s investment strategy and charges.”
The FCA is considering whether the failings warrant an official investigation by the Competition and Markets Authority, which has previously probed the much-maligned energy sector and payday lenders. Reforms likely to be introduced by the watchdog include “all-in” fee so investors know what they’re paying and the introduction of tools to help investors identify underperformance, though no detail was provided on what these could be.
David Ferguson, chief executive at Edinburgh-based investment platform Nucleus, said: “Shining a spotlight on the true fee active managers charge retail clients means the days of 0.9 per cent funds – which are probably nearer 1.2 per cent when other fees and turnover costs are included – might finally be over now that there is a requirement to present an all-in fee. This will substantially reduce revenue margins and should give rise to better client outcomes.”
Mr Ferguson dismissed the possibility that investment costs could ever fall to levels now enjoyed by institutional investors, around 0.2 – 0.4 per cent, as “cashflows are less predictable and liquidity is harder to manage”.
However, he added: “New technologies and better data analysis will be deployed to help bridge the gap, without necessarily resulting in a complete collapse in fund management profitability.”
The industry insists that it’s already cleaning up its act. The Investment Association said it had agreed with the FCA to adopt an ongoing charges figure, rather than an annual management charge, but that this has been scrapped in upcoming reforms introduced by the European Union in what the IA described as a “wholly retrograde” move.
So what should investors do if they want to make sure they’re getting good value for money? Here are some suggestions to consider (but please don’t treat this as advice, merely some ideas to bear in mind…)
Check out their past record but don’t treat it as gospel. The problem with active managers is that past performance is not necessarily a guide to future performance. Some may have timed markets well once but that doesn’t mean they have an innate ability to do it again.
Look sharp because active managers who beat the market are few and far between. Believe it or not, it’s actually very hard to suss out the wheat from the chaff because very few managers are able to keep up a steady track record and it’s recommended (partly due to cost reasons) that you don’t trade in and out of funds every five minutes (besides, who has the time?) However, there have been a handful of managers who do seem to have a knack of understanding where to invest and at what time (shame it’s only a handful). If you start reading the financial sections in newspapers/online, you’ll pick up tips about respected fund managers from (good) advisers and stockbroking services, who keep a close tab on these things.
Be patient. It’s not fair to judge a manager based on one year’s performance – you’ve got to be invested in the stock market for at least a few years, preferably five, to give yourself the best possible chance that you’ll ride out the highs and lows. Take this year for instance – should the FTSE 100 end lower than it did last year by December 31st due to Brexit blues and Trump tumult, you’d be foolish to sell out of funds that have been hit if there is a (very good) chance they will recover and possibly go higher in years to come (even if it takes a while).
Bear in mind that successful managers don’t always shoot the lights out but try to aim for steady returns. So picking the manager that achieved 25 per cent growth last year compared to someone who managed 5 – 7 per cent growth per annum over the last five years would be risky and quite frankly very dumb.
What about investment trusts? If you do a bit of background reading on this bunch, you’ll quickly discover that they tend to offer pretty good for value for money compared to active fund managers due to their very different structure – they’re actually publicly traded companies with a share price of their own, as well as being fund managers. So they have a greater eye to the long-term and tend to have a much better track record than so-called ‘unit trusts’. Also, there is a rather more transparent way to decide whether they’re worth investing in involving premiums and discounts, which I’ll definitely return to in a future blog.
How much is too much for an active manager? It’s hard to say because a good active manager would be worth his (or her) fee in gold but generally speaking, I think anything above 1 per cent would demand some solid and consistent returns (at least four or five per cent over inflation per annum to properly beat cash).
If all this sounds a bit too complicated to understand, I don’t blame you. If you don’t have the time or patience to keep tabs on good fund managers, you may want to track indices (like the FTSE 100) instead through a passive fund, if only because the costs would be lower and thus you would have less to lose, or invest your Isa through a wealth management service like Nutmeg, which helps you decide how much risk you want to take and invests primarily in exchange traded funds to try and make your investment goals happen. The fees are currently just above 1 per cent but this is the price you pay for handing over responsibility to an external platform and to be fair, Nutmeg has so far performed fairly well compared to its competitors. Fees also go down once you start investing more through the platform.
Whatever you do, diversify – so whether you decide to use an DIY investment platform or an online wealth manager, make sure you’re not concentrating your cash in a handful of investments, however promising they might seem. Spreading across different asset classes, funds, regions and sectors is the way to go. Like I say, please don’t take this as financial advice – if you’re really not sure, you can have a free consultation with a local financial adviser who knows their onions (go to unbiased.co.uk for reviews of the best advisers in your local area).