MARKET COMMENT
Fund Managers Increase "Con Factor"

By James Carlisle
August 20, 2001

Just when you thought some headway was being made in the battle against excessive charges, it appears that fund managers are increasing their charges. According to research from Fitzrovia, annual fund charges increased by 10% over a year ago.

This surprising news comes in the face of lower expected investment returns. In the world's major economies, the returns on Government bonds have been falling over the last decade or so. In the UK, the yield on a 30-year gilt has fallen from around 8.3% to just 4.5% in the last five years alone. The expected returns of all sterling-based investments, shares included, must now be lower to account for this.

The impact is substantial. Charges of 1.25% pa and investment returns of 12% would mean that you're losing about a tenth of your annual return in investment fees. If those charges rise to 1.5%, while the investment return falls to 8%, then suddenly you'd be paying fees representing more like a fifth of your annual returns.

The really disappointing thing is that the fund managers are able to get away with it. Before costs, the market, on average, can't outperform the market. On that basis, then the greater the premium that managed funds can charge over a tracker (something that, before costs, delivers the market return), the greater the amount we're being conned by their marketing. If average managed fund charges were, say, 1.5% pa and average tracker charges were 0.7% pa, then you might say that this "con factor" is 0.8%. That's what we're prepared to pay in the mistaken belief that it might do us some favours.

Part of the reason for the increase in fund charges is apparently that fund management companies are focusing on more specialised products. More specialisation does indeed sound like a good excuse for increasing the con factor. Don't believe the spin though. Investment funds focusing on narrow areas of the stock market are likely to be more risky relative to the market overall, without any real reason for expecting greater returns. On top of this, history suggests that just when retail investors are being sold funds specialising in a particular sector, it's time to move elsewhere. The massive demand for technology ISAs in February and March 2000 is a case in point.

Anyway, the bottom line is that actively-managed investment funds tend to underperform index trackers precisely because they charge more. If charges increase, then this degree of underperformance will increase.

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