David Kuo talks to David Norman.
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David:
This is Money Talk, the weekly investing podcast from The Motley Fool. I am David Kuo, and today we will look at how you could boost your investment returns by as much as a third -- yes, a third. Now, here to explain how it's done is David Norman from TCF Investment, who is a campaigner for transparency and fairness in fund management. So welcome to Money Talk, David.
David N:
Thank you very much.
David:
Okay, so tell me a little bit about yourself -- what did you do before you became a people's champion for fairness in fund management?
David N:
That's a very grand title which I'm not sure I can really live up to.
David:
Well, you did write a letter to David Cameron, so that makes you a people's champion.
David N:
Yeah, okay -- fair enough, okay, I'll take that. What did I do before? -- a very long history. Originally I started off as a chemical engineer with GEC, then I moved into financial services a long time ago, more than 25 years ago now. I've worked for lots of different companies, so London Life, Scottish Equitable, the Pru, Threadneedle, Friends, Insight, Malley, Aviva, and most recently was Chief Exec of Credit Suisse, which I guess says I can't hold a job down. Then, two and a bit years ago, I founded a company called TCF Investment. We, myself and my business partner, Gary Mairs, sat in my conservatory and said, the industry has a huge amount to offer. Looking after people's money and looking after people's money well is a really valuable product and service to offer. Why can't we use the skill and knowledge that we've got, over 25 years' each experience of doing this stuff, but design a company the way a customer would design it, if they knew what we knew after 50 years of experience. So just keep it really very simple, do some simple things that work: diversify; don't invest in stuff you understand; keep the costs low. As funds get bigger, make them cheaper, because there are economies of scale.
David:
So what is it that pricked your conscience? Why have you turned from poacher to gamekeeper?
David N:
Financial services as an industry has a very privileged position. It has a huge amount to offer. We can't do sex and whoomph, but we can do financial security. We can look after people throughout their lives. There are some very simple things the industry does very well, term assurance -- if you die, yes, you can't bring the person back, but we can provide financial security for the rest of your life. We should be able to do the same thing for pensions for investments, for saving for the future. The industry has a huge amount of very, very clever people that have the skill and knowledge to be able to do that. All they have to do is focus single-mindedly on the consumer, and if you do that all the time, you will build a brand, you will build a reputation, and people will trust you, and they will give you more money, and you can charge them less, and you'll get richer, and they'll get richer.
David:
It's as simple as that?
David N:
Well, that's all it is, isn't it? Why do people invest? I invest my money so it will work hard, so that I don't have to. Why otherwise would you invest? Some people invest for fun, but actually you're trying to do it with an end game. I'm trying to get to the stage where my money's working hard, and I can stop working so hard -- that's all it's about. If the industry can use those very simple rules, and just focus on the consumer, that will be a great outcome for everybody, and then we'd have a world-class industry in the UK and the money would flood in from Europe, which would really annoy the French, but it's just so simple.
David:
I want to go back to your university life, David. Did you know that you, Angela Knight, Margaret Thatcher and myself have something in common?
David N:
Gosh!
David:
We all did chemistry at university.
David N:
Okay, well I can cop out of that, because I didn't go to university -- I did it through further education, but yes.
David:
Same thing, so what is it about chemistry that makes people change their directions in life, and sort of say, I've done chemistry -- I don't want to do this anymore. I want to do something completely different. In the case of Angela Knight, she went on to become an MP; Margaret Thatcher went on to become Prime Minister; you went into the fund management industry; and I went into The Motley Fool. So what is it about chemistry that turns people so off that subject? It's a very philosophical question.
David N:
Well, underneath me, in terms of how I look at things, is a scientist. That's the way I approach things, and chemistry is all about trial and error; hypothesis -- go and test the hypothesis, does it work? So 25 years of financial services, working for life companies, for banks, for asset managers, in lots of different roles, in sales, in marketing and operations, when you have children, you always go through that very strange process with them where they come up to you and say, “ Daddy, why is it raining?” “Well, because the water goes in the clouds.” “Why?” “Well, because the sun heats the clouds ... “ “Yeah, but why?” -- and they just keep asking, why? And it's a really tough question to ask. Kids are brilliant, because they learn and they learn and they learn and they suck up information. As we get older, we stop asking why. So we set up our business, there's some fees involved, and the custodian says, we're going to charge you x pounds per line of stock -- why? -- well, that's what we charge. But if I was a private investor, and I went to a share dealing platform, it wouldn't cost as much. So why, as an institutional investor, are you going to charge me? Oh right, yes -- nobody's ever asked us that before. That's not my problem; that's their problem. I have my money in my funds -- I want the best deal I can get at the cheapest price. Why? -- because that's what my customers expect me to do; they expect me to use my knowledge and experience of asset management to do a good deal for them. Why? -- because then they'll trust me. Why? -- because then they'll give me more of their money. Why? -- because they'll get a better income in retirement. It's very simple stuff.
David:
So what are the typical fund fees here in the UK, then?
David N:
The average total expense ratio across UK retail funds is about 1.7%. It's gone up from about 1.55 over the last ten years, which is a great example of how to bamboozle people. Well, that's only 0.15 of a percent -- that's not a lot. When you look at it, if you look ten years ago, the total funds under management in the industry was about 250 billion of retail assets. It's now over 500 million. The number of funds hasn't changed, so what's really happened is the average fee that a fund manager used to charge was about 1.9 million per year, and it's now just over 4.2 million per year. So fund fees have gone up at 9.2% per annum, which sounds like a very different number too, it's gone from 1.55 to 1.7, because the industry (and that's a great example) gets rich by running big funds. It doesn't get rich by running good funds. It's just about a sales and marketing machine to capture assets, and then it can charge a bigger fee.
David:
So the point is, why are the fees charged by the various fund managers very similar? What is the cause behind this, because if you have a look across the funds, there isn't a great deal of choice, is there?
David N:
No. If you look at similar funds across groups, there's only about six basis points, so .06% difference from one fund to another, on average. Why is that? -- that's a very good question. It's a question I asked the Treasury to go and find out. I have some thoughts about why.
David:
And what are your thoughts?
David N:
Well historically, the bulk of distribution, so the bulk of fund selling in the UK, was through an intermediary, either through an IFA, or through a life and pensions wrapper. Historically, because it's been the fund manager that's paid the trail commission, or paid some incentive to those advisors for selling their product, effectively they've been distributors of those products, it's not been in the distributors' interest to challenge the price, because if they challenge the price, they're actually cutting their own nose off. So the way the industry's been structured has not been in the interest of the consumer, so there's been no pricing pressure, if you like, from the distributor that has been the bulk of sales to the consumer.
The other issue, I think, is because the industry is brilliant at bamboozling people, and the more it can bamboozle people, the less price competition there is. The annual management charge is the bit the fund manager takes, which is not the total cost of the fund, because that's the total expense ratio, which of course is not the total cost of running the fund, because on top of that you've got all sorts of other charges.
David:
So what you're saying is the total expense ratio is not the total cost of running the fund?
David N:
Absolutely.
David:
So why is it called the total expense ratio, then?
David N:
Because it's a great way of confusing people into thinking it's the total cost. Five years ago, nobody would have disclosed the total expense ratio, so you'd just have disclosed the annual management charge. The biggest example, and I admit it is extreme, I found a fund that had an annual management charge of 1.9, and a total expense ratio of over 8%, so the gap between those two can be quite big. But all of the cost of trading inside the portfolio, of buying and selling the stocks inside the fund, are not in the total expense ratio. If the manager can add skill, and therefore by trading, add value, great; but what I want to see is, why can't I see what the typical cost of that trading activity is, or how much that activity is, because then I can make a judgement about whether I want to take the risk of you trading my portfolio a lot to try to deliver me value. So show me the trading costs over a reasonable period of time. It's just like if you go to buy a fridge. If you wander into John Lewis, you can buy famous brand A and famous brand B. One's £600 and one's £570. The £600 fridge is double A-rated for energy, and the £570 one is G-rated for energy. Which one are you going to buy? Well actually, I'm going to keep this fridge for ten years, and I can see that that double A-rating is going to be far more efficient to run. I go to buy a car -- yes, I can buy two 1.8 -- I'm doing the same process now, looking to buy a car. Which one is the cheapest to run? -- well, this one is £7,000 and this one is £8,000. Well, it must be the £7,000 one. Yes, but this one has a higher insurance group, has a higher vehicle emissions duty, has a servicing ... so I want to see the running cost, as well as the price. So the total expense ratio is the price of the fund -- what's the running cost? -- I can't see it. So if you can't see it, how can there be price competition?
David:
So are you saying that fund managers turn their portfolios around too much, then?
David N:
If you can't see how much they're turning it over -
David:
Because each time they turn it over, they're going to have to start paying costs, aren't they?
David N:
Yes, and if you're a skilful manager, and you can add value on top of the total expense ratio, and on top of your trading costs, then fine -- I can make a decision to buy you. The issue is that, on average, that's not going to happen, because if you've got an index or a market which has no cost, and the average manager is charging 1.7 (this is the kind of active versus passive argument), the average fund is going to be 1.7% less. But actually, the 1.7 isn't the total cost, because actually there's all the trading costs on top, so it's going to be the 1.7 plus the trading costs. Now, some will outperform. Trying to spot them in advance is incredibly difficult. But if I could see the running cost and the cost of the fund, then I can make a decision. Some bond funds will trade their portfolios enormously, so you can see turnover rates of 4,000%. So they're turning over their portfolio 40 times a year.
David:
Which they have to, because some of these funds will actually reach their maturity date, and the fund manager will have to get rid of them?
David N:
Exactly, but the spreads on the products they're selling underneath are tiny, so the impact of that cost is tiny. If you are buying a small cap, then the spreads that you'll face every time you buy and sell a liquidity issue is going to be enormous. So if you are turning over your portfolio regularly, I'm concerned that, can you deliver that outperformance on a regular basis? -- whereas a longer term buy and hold investor with a lower turnover probably stands a better chance. If I can see that information, if that was ... I mean the key investor information document which is now going to replace the simplified prospectus, because it wasn't simple enough, because it was 78 pages long, doesn't have turnover rates -- why not? That's got to be a key part. I want to see what activity this manager's delivering. In the US, you can see on the prospectus, you can see the five years' previous turnover. It's got to be disclosed, for people to make better decisions.
David:
But does the investor really care about this? If I, for instance, was investing in a fund run by Anthony Bolton, and I know that his track record has been pretty good, and he says, “David, if you want to buy my fund, we're going to charge you something like four or five percent” -- do I really care if he is capable of delivering returns in the teens, that he's going to be charging me four or five percent?
David N:
Probably not. What was his turnover rate? What was his strategy, to deliver that return? Was he actually a long term buy and hold investor, and actually that's the way he was making money?
David:
But do I care though, as an investor? -- or should I?
David N:
Well I think you do - yes, you should care, because ... well, two things. One, costs are absolutely certain. If you put £10,000 of investment in, and there's a charge of £100, that £100 has gone and gone forever, but so has all the potential growth on that £100 gone, and gone forever, so it's absolutely certain. Performance, will I beat the market? -- that's random, or maybe slightly skewed in one direction or another. So costs are absolutely certain, and performance is not. So on that basis, you need to understand all the costs, because that's the only certainty you have with investment. Then in terms of making your decision, what are the drivers of long term performance? What is going to make the difference? There is lots of research started by, backed by William Sharpe, looking at turnover rates and portfolio turnover. Even Morning Star, the ratings agency in the US, did a great piece of research looking at what is the best predictor of future returns? Is it star ratings, or performance? -- and what did they discover? -- costs are a really good predictor of star ratings, because for two reasons: one is lower cost funds consistently outperform higher cost funds, and also higher cost funds tend to get merged away. They disappear out of the league tables.
So when you're making your decision about, I want to make an investment; yes, you want to look at manager skill, if you believe that exists, and part of that is then you want to be able to look at the cost, because the cost is certain, and the skill is not. I think your point about charging more for performance -- absolutely right. I'm a big fan of performance fees, if you're setting out to outperform, but they have to be aligned with the customer's interest. At the moment, most performance fees in the UK are aligned with the fund manager's interest, and only the fund manager's interest. We can charge you more if it goes up, but we don't charge you less if it goes down. That's a bad outcome. If you took the benchmark as being the cost of running an index tracking fund, and you charge that, and then if you delivered, let's say, 5%, then I'll charge you a little bit, and if I charge you more than that, I'll take a share of the fee. If i don't perform, I pay that fee back.
David:
Well, I'm glad you mentioned index tracking funds, and low-cost exchange-traded funds. We know that they are immensely popular here in the UK right now, but with the advent of the ETFs and the index trackers, why hasn't it brought down fund management fees, which is really what it should have done? If I had the choice of either spending, putting my money into an ETF and paying 0.5%, why would I not do that in preference to say giving my money to a fund manager who's going to be charging me two or three percent?
David N:
It's starting to change, and you have seen some fund groups launching lower-cost versions of funds. Some of it is clearly, why don't you just drop the price of your fund book, rather than actually launching a new fund with lower cost -- well, we all know the answer to that one. But it's starting to move -- if people do it, other people will copy it. It takes a long time for the embedded practices and procedures of the industry to change. The fund industry is a very powerful sales and marketing industry. It's very good at, you pick up any money supplement or any Sunday newspaper, and it's full of advertising about how great the past performance is, despite the fact that every single advert says, past performance is not a guide to the future.
David:
But that's all people have, though? -- because ultimately, not many people know about say, well, a typical investor may not actually know this particular fund manager, what he does, and they're not as widely written up as say somebody like Anthony Bolton, or Neil Woodford. People probably even know what Neil Woodford has for breakfast these days, because he is so well documented.
David N:
That's a big part of the gap, which is, the industry is playing the game on its terms. The industry is playing the game on performance, and star managers, and wonderfulness, and the hot story, and should you be in commodities, or should you be overweight this, or underweight that, and what should you do, because that's in the industry's best interests. So it creates this hype, if you like, around, this is what investing is about, short term: it's about trading, it's about taking a risk, it's about looking at an opportunity on a short-term basis, when investing is a long-term, it's trying to build you a pot of money for the future. It's about sound investment principles, of which cost, diversification, understanding the risks that you're really taking, are the fundamentals, and trading around the outside are not. Now, some investors will disagree with that, and will say, I want to be able to pick, I want to be in and out quickly. I want to be overweight gold, and then into cash, and whatever -- great, and some people will do well at it. Most people won't. The fund industry does the same thing, the things it gets wrong gets buried, because the funds get closed or merged. It's quite frightening -- I mean, if you look ten years ago, there were about 2,400 funds, retail funds in the UK; today there are about 2,500. Over that period, 2,500 new funds have been launched, and 2,400 funds have been closed or merged away. That's how good the industry is about long-term -- and this is about long-term investing. Every single advert will say, invest for the long term, but you launch your fund and shut them every five years; why? -- because some do well, and some don't do well. So all of this noise is going around, and you only hear the good stories. You never see an advert that says, we had four really good funds and ten really crap ones, because you wouldn't do that -- you only see the good stuff. So everybody gets all of this noise about the good stuff, and actually very little about ... the Morning Star did a global investor study. They looked at about 17 countries, and they looked at regulation, tax treatment, transparency and investor information. So they looked at those kind of four different categories around the world. The one thing they noted in the UK was, it's pretty good regulation. You've got USIT, so they're fairly well covered. Distribution is predominantly through advisors, and the media doesn't talk about costs at all, and they're the things they noticed. We talk about past performance; America and other parts of the world are much more focused on the importance of cost, and the impact of that on long-term investing.
So it's starting to change. The arrival of people like Vanguard in the UK makes a lot of noise about cost, and the issue about cost and transparency. Other people are doing the same thing. It's starting to move. There are changes, the FSA with the Retail Distribution Review; the change in the way that advisors are paid, so commission effectively is abolished from 2012. There's a for and against the abolition of commission, but what it does do is it means the advisor now is on the side of the consumer. The advisor is the agent of the consumer, and no longer the agent of the product provider, so therefore he has an interest in the cost of the product he's selling, and he will charge you a fee for that process, in which case, if he gets you a good deal, he can probably charge you a better fee. So suddenly, the balance is tipped from the providers effectively recruiting distribution, and the distribution being an agent of the provider, to actually the distribution being an agent of the consumer. In those circumstances, they will need to justify why they're recommending a product, and cost for investment will become a critical part of that. So it'll shift, but it'll take some time.
David:
But how we can improve the information that the private investor is going to be getting, because as you alluded to earlier on, the poor-performing funds are just simply written off the league tables, so they no longer exist? So all that people have to compare are what are actually remaining, and what are actually sort of good. So how can the private investor make a choice, given that the information is going to be skewed in the direction of good-performing funds anyway?
David N:
It's tough, is the answer. You need to do your homework, or you need to find somebody, a trusted advisor, who's actually going to be able to do that work for you.
David:
But he's going to be reading off the same tables as everybody else?
David N:
Exactly, so you have to have an advisor who understands the difference, who actually, if you want to compare the performance of a fund, you need to make sure it is the track record of that fund, and you need to compare it against an index, not against the sector average, because the sector average will be full of survivorship bias and all sorts of other noise. It's part of the things that we do, when I wrote to the Treasury, there were a number of things that I think, if, from the bigger perspective, the government, whatever colour of government, has an interest now, it can't afford to provide the state pensions and to provide the pensions that it's promised. It's going to come to us as an individual. If the government doesn't make sure that the industry is extremely well-regulated and transparent, people are going to lose trust and confidence in it, because they can see, the market does x, and yet their ISA statement says x minus something -- I can't work out how the market does this, and I don't get it, so I know something's going on. I may not know whether it's repo arbitrage, or securities lending, or some custody fudge, but I know that what's going on over here is not what I'm getting, and I'm getting cross about it. To your point about, when returns ten, fifteen years ago were in the twenties and thirties, if you lost three or four percent per annum because of charges and things, it didn't really matter, because 20% minus three was still a good return. In the return environment we've had for the last ten years, when returns have been six, seven, eight percent, and if we keep getting returns of six, seven, eight percent, costs of three, three-and-a-half percent per annum are unsustainable, because people will go, it's not worth me saving. I will be better off in the building society, even though the building society is paying me 0.01, or whatever it is, so people will stop saving for the long term. The government ends up in a situation with, well we still have to provide the pensions for them -- they're not doing it themselves. There's only one answer: tax. So my view is, in the long term, the government needs to get hold of this, and get hold of it properly.
David:
Long term government thinking?
David N:
Yeah, I know.
David:
Does that ever exist?
David N:
Well, yes.
David:
They can only see as far as the next election!
David N:
If you create an environment where the UK have a really robust and well-trusted investment industry, with the way that global trade exists these days, we can become the savings capital of the world. You could pull in assets from the whole of Europe, because if you want a well-regulated product where you're extremely well looked after, and actually the charges are fair, and it's completely transparent, and I get a good deal, you want to go to the UK to do it, that would give us a huge export opportunity. So yes, it needs to be done for the long term, because we need to build more trade with the rest of the world. We're not going to live by selling mobile phone insurance to each other for the next twenty years.
So if for the industry, my view is, if government can intervene, and create an environment where we build a huge amount of trust and confidence, because we are transparent and we are lower cost, and we deliver really good value for consumers in investment, more people will invest. The really curious thing is with investment, every pound of the cost is a pound that's lost. If the industry takes less out, and the market grows, the pot at the end is bigger, because you've taken less out. Even though your percentage fee is lower at the end, you're taking more money, because the compounding effect of the growth is bigger. So the less you charge the customer, the richer you get, and the richer the customer gets. That, to me, seems like a pretty good reason for becoming the place in the world where you want all the money to come, and guess what? -- we'll have richer pensioners. It's kind of the big law of little numbers. There's an example, there was a newspaper story a couple of years ago about an investor who'd put in £70,000 over fifteen years into his pension pot. Over that time, the FTSE had gone from 3,000 to 5,000, so he'd seen 66% growth in the market. When he got to retirement, his £70,000 of contributions was worth just under £70,000, and the journalist had written, how on earth can this possibly happen? The reason it happened is because the charges were about 3.1% per annum. 3.1% per annum over fifteen years is 66% - that destroyed the growth. That seems quite high? -- well, the average total expense ratio was 1.7; trading costs of 1.3, 1.4 in a fund, it's quite easy to achieve those, so there's your 3.1%, being eaten away.
If we made those costs just a little bit smaller, so let's make them 1.4, instead of 1.7, and we make those turnover costs 0.6 instead of 1.4, that makes his pension pot 24% bigger. So it's not just his pot is 24% bigger, his income for the rest of his life is 24% bigger. We could do that for the whole industry, quite simply. So suddenly, in ten years' time, everybody's pension pot is 24% bigger than they thought it was going to be. That's a really big number, and actually all you've done is taken 0.6 and 0.3 out of the pot. That's why those little numbers, over the long term, make a huge difference. Then the government can start taxing pension funds, which it's going to do anyway, and we'll still be richer.
David:
Now, the British fund management industry is estimated to be worth around £600 billion.
David N:
Yes, retail funds.
David:
Retail funds -- is that about right?
David N:
Yeah, that's the IMA numbers -- about £570 billion, I think, end of last year.
David:
Okay, we'll call it £600 billion. So how much are private investors paying in fees on that £600 billion?
David N:
Too much. It is complicated, because some of that money will be directly held, so you'll be paying your standard annual management charge of 1.7 or 2.3, if it's a multi-manager fund. You'll be paying trading costs on top of that. If you call them broadly, so if it's about 1.7, and you're paying another 1%, you're paying about 2.8% per annum across the board. Some people will have discounts, because they'll be buying funds through pension fund wrappers where there'll be a rebate, but who's getting the rebate, and who's sharing the rebate? If you're buying it in a life company wrapper, it's a white label fund -- again, it's hard to see some of those costs. There is quite a lot of regulation around mutual funds, around unit trusts, etc, which makes the pricing, certainly the total expense ratio, reasonably transparent. That regulation doesn't necessarily exist in other wrappers, so in life wrappers and pension wrappers, the legislation is less strong. There's a long way, in my view, for USITs etc and unit trusts to get in terms of transparency, but at least unit trusts are some way down the road. It's very hard sometimes to find all those costs, because they appear, certainly in old contracts. That's the thing -- new products are getting better and potentially more transparent, but there's an awful lot of people with an awful lot of savings wrapped up in old products with initial units, capital units, redemption units, market value adjusters, so I'll charge you or I'll charge you or I'll charge you, and that makes it even more complicated.
Why do I say it's too much? If the industry has doubled in size over ten years, and the total cost of it went up, that's not right, because the economies of scale ... investing is a very simple thing. If you've got a fund manager and a fund, and he's got £100 million, it doesn't cost much more to run it with £200 million or £500 million or a billion. In fact, if you look across the US, France and Germany, so for big mutual fund industries, as funds get bigger, their total expense ratios come down. In the UK, they stay exactly the same. So there is, I would argue there is compelling evidence that the UK fund industry is not doing a good job, because the total expense ratio should come down as funds get bigger. The industry will say, ah -- but regulation's more expensive, and I will go, but look at the technology that's available now, compared to ten years ago. Look at how much share dealing has come down over ten years. Why are those benefits of scale not being passed to the investor? And some of those issues are wrapped up in complexity.
I think, my personal view is, the IMA could do an awful lot more to promote wider mutual fund ownership by doing things to kind of put better infrastructure in place, by providing better education, and really pushing the agenda to demonstrate how good the industry is, and what value it offers by being completely transparent. It's no good having an argument about how much the hidden costs are or not -- there just shouldn't be hidden costs, because if you're having an argument about hidden costs, you're having the wrong argument.
David:
So what can the private investor do, David? -- given that the fund management industry isn't likely to cut their fees and their charges tomorrow, the private investor still needs to survive today. So my final question to you, David, is what can the private investor do now in order to try and boost his returns, so that they can actually retire in some kind of comfort?
David N:
If you're going to buy mutual funds, one of the biggest determinants of your long-term future return is cost. So understanding what the total expense ratio of the product that you're buying is very important. I would argue, and others will have a different view, that it is very difficult for a fund manager to consistently deliver value over an index in the long run, because he has two barriers: one, he has the cost, the annual management cost and the total expense ratios; and two, the trading costs. An index fund, I mean the Vanguard fund range, we talked earlier -- 0.4, 0.5% per annum with tiny turnover, because it's tracking the index, so you've got a good diversification of stock. So putting together a portfolio of passive funds, with low costs from reputable providers in simple vehicles, for most people for most of their money, is the best way to get a better retirement, and you'll be saving, you could be saving yourself easily 2.5, 3% per annum, and for a manager to deliver 3.5% per annum of consistent outperformance is very rare. Yes, there are the odd Anthony Boltons, but trying to pick the Anthony Boltons in advance of Anthony Bolton doing it, and keeping your fingers crossed that Anthony Bolton does it every single year ... Woodford has a strong following, but he has good years and bad years, and he's coming off two years of not very good performance, and he's doing well. Well actually, I'd rather not have the two years of bad performance, and the one year of good performance -- I'll just have what the index does. It's horses for courses.
Using index funds, using simple index mutual funds to drive the cost out of the core of your portfolio, keeping it well diversified, and don't fiddle. The best way to fiddle is to do rebalancing, so if you set your portfolio up at the beginning of the year, and you say, I want to have 60% in equities and 40% in bonds, and at the end of the year, if bonds have done well and equities have done less well, you have rebalanced to get back to that 60:40. So let's say you've got to 55:45, it forces you to sell some of your bonds and buy equities. You've been forced to buy the things that went down, so you buy low, and you're forced to sell the things that went up, sell high.
David:
Just mechanically?
David N:
Mechanically, automatically it happens. The great thing about diversification and rebalancing is, it makes you automatically do the two things that you can't do on your own. With all of my knowledge and experience of working for all these industries, slowly over the years my portfolio's gone from a range of, I can pick this, I'm a clever bugger, to actually, I'm trying to provide a pension. The thing is, when you get it right, in 2008 my view was there was too much risk around. So despite my best intentions, I moved quite a large portion of my portfolio into cash. My finance advisor said, you know you can't time the market? I said, I know you can't time the market, and I was right. So a bit of luck said, what did I then do? -- I sat in cash for too long, and missed it going all the way back up again, because the thing is, once you make a good decision, you think you're good.
David:
We're all geniuses, as long as we know ... !
David N:
Exactly -- one piece of luck turns you into a genius. To prove categorically that a manager has skill, rather than he got lucky, I think you need something over 174 years of performance track record to prove conclusively that they have skill, rather than luck. I think I'll just go with the index, and let somebody else worry about the 174 years, because I ain't going to be here.
David:
Okay, I think that's a great place to stop, David. The thing is, I have around 15 shares in my portfolio, and I've kept them for close onto over ten years now. I haven't changed the type of shares in my portfolio at the moment. I get lots of dividends from there, and I rebalance in a slightly different way -- I just keep on topping up all the shares that have actually not done well. It's as close to a perpetual investing machine that I can get.
David N:
And in the long run, technically you're trying to pick up the equity risk premium. You're trying to take up a bit of premium, because you're giving your capital to somebody else who can invest it and do very well. So companies listed on the UK stock market are extremely well regulated. We have one of the best regulated exchanges in the world, so it's pretty transparent and pretty good value. Lots of the big companies on the FTSE 100 are internationally-diversified. Their income is coming from around the world. A lot of people talk about investing, the East/West argument. Credit Suisse did a big piece of research, looking over 100 years. There was no correlation between GDP growth and shareholder value. Tesco will make money if China grows, because Tesco has a footprint. The value will emerge on the UK stock market. So a well-diversified portfolio across companies from different sectors, in a low cost book that you just leave alone and don't fiddle with, is going to do you a good job. You're taking more risk by only holding ten or fifteen stocks. Some people might want to take more diversification, maybe buy some UK stocks because it keeps the price down, but then put an international fund and a bond fund. If you want diversification of bonds, buy short-dated bonds. Why? -- because long-dated bonds are volatile. You won't get a very good return -- no, but it's not bumpy.
David:
It's not rocket science, at the end of the day, is it? It's more like chemistry, isn't it? -- just the building blocks of life.
David N:
Well, it's just being aware of the ten simple: costs really matter, diversify, rebalance. Don't believe anything that anybody in fund management tells you, certainly don't believe their adverts. Past performance is not a guide to the future. If you don't like risk, do it on a regular basis. Time is really important. Time will reduce volatility, dripping a little bit in each month -- you won't get such a good return, but it will reduce the volatility. It's those very simple things, and that's what, the trouble with those, and it kind of comes back to your earlier point, writing ten really boring guides of how to make money, and they're really simple tips, does not sell lots of newspapers. This hedge fund manager, I think, that commodities are going to triple and gold is going to go past $3,000, and this guy thinks the commodity boom is over, and having a good argument, is a much more interesting way of selling newspapers. The sad thing is, it makes those guys rich, not the end investors.
David:
That is a wonderful place to stop, David. Thank you so much for coming in today. Before we bring the podcast to a close, I need to find a quotation that I hope will encapsulate the spirit of today's chat. I think I've found it -- the quote comes from an 18th century German scientist called Georg Christoph Lichtenberg. Now, Georg Christoph Lichtenberg said, “The most dangerous truths are truths moderately distorted.” So quite often the things that you think are truths, but just moderately distorted, are actually more dangerous than lies in total. So thank you very much for coming in today.
This has been Money Talk, I have been David Kuo, and my guest has been David Norman from TCF. If you want to know more about what is going on in the world of finance, you can sign up to The Collective, by going to fool.co.uk/davidkuo. Until next week, have a great week, everyone.
