MONEY COMMENT
Even The FT Is Becoming Foolish

By Cliff D'Arcy
April 3, 2003

I was reading the monthly FT Money Guide (a 20-page piece on "Investing in ISAs for Growth") earlier this week. A couple of comments in this guide really caught me by surprise, so much so that I resolved to write about them.

Of course, the majority of FT articles follow the party line adopted by the national press: that investors should buy managed funds (which, unsurprisingly, are massive advertisers in the quality press). These articles trot out the familiar line that inexperienced savers should take advice from an IFA before buying an Individual Savings Account (ISA), while experienced investors should buy through fund supermarkets to cut initial and annual charges.

However, on page 12, in an article entitled, "Wake up to hidden costs", the FT debunks a few myths about fund managers and their relative success. The writer, Pauline Skypala, explains that many investors make the mistake of piling into funds near the top of the historic performance tables. This is chiefly because the investment industry emphasises past performance over all other criteria.

However, the Financial Services Authority (FSA), the investment regulator, has pointed out that past performance is a very unreliable predictor of future performance. For example, most TMT (technology, media and telecoms) funds did marvelously well up to 2000, yet have under-performed massively since then.

The FT refers to the comparative tables on the FSA website (which rank funds based only on charges). These show that the total charges on a lump sum of £7,000 invested in a low-cost index tracker (one of the most Foolish products around) amount to £672 over ten years – that's 9.6% of your initial capital. Compare this to the colossal charge of £3,510 for the services of a "specialist focus" fund manager, amounting to over half your original lump sum!

The only way that this "specialist focus" fund manager could out-perform the humble tracker would be if s/he beat the market by several percentage points, year in, year out during this ten-year period. However, all the evidence suggests that fund managers have their ups and downs (just like other mere mortals), with their relative performance often being affected by repeatedly changing investment fashions.

These FT quotes are worth remembering:

"Cost is the only variable you can rely on. Everything else, including performance, volatility and investment style, is historical information that could change in the future."

"A low or nil initial charge is attractive, as it bumps up the amount of your money that is working for you from the outset, and gives a significant short-term advantage."

Ms Skypala then goes on to warn that high annual management charges, including marketing and other expenses, make a significant difference to long-term performance. Even a tiny difference in total expense ratios (TERs) is critical: paying annual charges of 0.75% instead of 0.5% will cost you £300 more over ten years. Here's another weighty quote from the FT:

"Why would you pay a TER of 2.05% on Jupiter Income & Growth, when it has lost just as much money over five years as Legal & General UK Index, charging 0.55% TER?"

Now, can you guess which of these funds the Fool is delighted to promote on our site. Find out here!

Here's the final paragraph of Ms Skypala's article:

"With returns expected to remain sluggish for some time, low charges are becoming increasingly attractive. It is time for investors to wake up and pay attention to one of the few certainties in the investment world."

So, there you have it: a Foolish call to arms from the revered FT! But that's not all; I then came across an article by highly respected financial journalist Philip Coggan. In his article on stock-picking systems, "Are all systems failing?", Mr Coggan reports on the relative performances of several virtual portfolios created over previous months. I'll cut to the chase; here are his last two sentences:

"The whole process (i.e. stock-picking) emphasises the advantages of index-tracking funds. But perhaps the next few months can turn things around?"

We'll just have to wait and see, won't we?

Visit our ISA centre. Be warned: the deadline for the 2002/03 Tax Year is Saturday, 5 April and is approaching fast.