Fund managers say they're 'worth it'. But is it true?
It is, in short, turning into quite a war of words. And today, the volume has ratcheted up another notch. The issue at hand? Fund manager fees.
Here at The Motley Fool, we've long campaigned against excessive fees charged by investment fund managers, and urged investors to vote with their wallets and buy into funds with low fees. Ideally, in fact, index tracker and ETF products, which carry the lowest fee structures of all.
More recently, the focus has turned to total expense ratios (TERs), and the question of 'hidden' fees. Simply put, the FSA-mandated formula for calculating the total expense ratio doesn't, in fact, include everything.
In particular, trading costs and the impact of stamp duty are excluded -- which, in the case of an actively managed fund, can add up to quite a bit, claim critics.
At this point, I'll say no more by way of recapping the issues. If you want to know more, then this article and this article will quickly bring you up to speed.
Rebuttal
The investment funds' trade association, the Investment Management Association (IMA), has today released the results of an analysis that it has carried out.
To begin with, it points out that so-called 'hidden' charges have to be disclosed to investors, and are readily in fund literature. In other words, they're not really hidden. Maybe so, but the fund literature in question is often the full prospectus, which -- in my view -- many investors never look at.
But, that said, from a study of this literature, it has established that the average transaction cost incurred by a sample of large UK 'All Companies' funds amounted to 0.31% of average assets -- of which, two‑thirds was accounted for by stamp duty. Whereas in tracker funds, transaction costs totalled just 0.06%.
Case proven? Not quite. Despite active funds incurring transaction costs equivalent to over five times those incurred by index trackers, the IMA then asserts that the difference is worth paying, as "transaction costs were more than covered by the investment returns from active management".
How so?
The argument boils down to this.
First, the IMA looked at the performance of 129 funds -- both passive and active -- over a 10-year period, comparing them with their benchmark. It then compared how trackers had performed with how actively managed funds had performed.
On the whole, as you'd expect, the difference between the performance of an index tracker and its benchmark corresponded almost exactly with its TER. Put another way, on an income-reinvested basis, the average FTSE All-Share tracker had an annual TER of 0.80%, and undershot the FTSE All-Share itself by 0.79%.
Actively managed funds, however, undershot the FTSE All-Share by 0.63% -- yet had an average TER of 1.56%.
In other words, says the IMA, active fund management overcomes the impact of high transaction costs. And, what's more, it also delivers a slightly higher overall return -- 4.04% on average, versus 3.87% for a tracker.
Charitable interpretation
Interesting results, to be sure. And Richard Saunders, chief executive of the IMA, was keen to use them to dispel the myth of hidden fees, even if that's not quite what his organisation's results actually prove:
"The IMA's figures demonstrate clearly that so‑called hidden charges that cost investors billions a year are a complete myth. If the accusation were true, it would show up in the net returns achieved by investors. But there is no sign of it. The accusations of hidden charges do not stand up."
Mr Saunders is entitled to his view, of course, but I prefer an alternative explanation -- the charges are there, but active management in part compensates for them.
Dispersion around the mean
But, of course, these results also sidestep around a much bigger difficulty with actively managed funds and their fees.
And it's this: whatever the average fund achieves by way of performance is irrelevant. The investor is only interested in the performance of the funds in which they actually invest. And, compared to trackers, the performance of those funds will vary far more widely around the average.
Trackers, in short, track. Alright, tracking errors and fees have a bearing on a tracker's performance, but a FTSE All-Share tracker should still adhere much more closely to the FTSE All-Share than an active fund, which -- by definition -- isn't aiming to track the FTSE All-Share.
In short, I'd rather put my money in a tracker and know more or less the performance that I'm going to get, relative to the index, than put my faith in a given fund manager's luck or skill.
But that's my view. As ever, feel free to share yours in the box below.
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