The Skids Are Under These High-Priced Flops

Someone I know has just over £75,000 invested in the stock market. That's the good news. The bad news? It's invested in various multi-manager Fund of Funds products, sold by a variety of the usual suspects.

Now, let's be clear. Stripped to its essentials, there's nothing really wrong with a Fund of Funds. Rather than having your money in one fund, you put your money in a fund that itself invests in other funds -- hence the name.

The logic? The manager is free to pick funds that are doing well, and avoid funds that aren't doing quite so well.

Plus, of course, in-built diversification. By buying a single over-arching fund, an investor can gain access to bond funds, equity funds, emerging market funds, gilt funds, property funds -- pretty much an asset allocator's dream.

Premium price...

Now, that's what is good about multi-manager Fund of Funds investment products.

But here's what isn't so good: the charges. Simply put, you pay a charge to the manager managing the top-level Fund of Funds itself, and then -- naturally enough -- charges to the managers managing the individual funds that the Fund of Funds is invested in.

And without exception, the TERs are all above 2% -- with the highest standing at a whopping 2.53%. That, in short, is an awful lot of the FTSE's return to give up in exchange for an element of diversification and a supposedly superior performance.

... but not premium performance

Now, the astute among you will have registered the word 'supposedly'. And, in fact, as my Foolish colleague Harvey Jones revealed a few weeks ago, that superior performance turns out to be difficult to detect.

Independent financial statistics and monitoring company Defaqto, for instance, rated 184 multi‑manager funds, and found that only a few had delivered an acceptably consistent performance since June 2008 -- just 25 out of the 184, in fact.

In short, the majority of investors are paying for a performance that they aren't getting.

Goodbye commission

But the penny, it seems, is dropping. Both among private investors, and investors who are guided by IFAs -- IFAs who, of course, in a post-RDR world, aren't going to be able to collect fat commissions for pointing investors towards multi-manager Fund of Funds products.

And what do we see when we look at the very latest figures from the fund managers' collective body the Investment Management Association? Just that trend starting to happen, I believe.

Funds no; trackers yes

See for yourself. At £396 million, sales of Fund of Funds products during the first quarter of 2012 were at their lowest level since the fourth quarter of 2008. Tracker fund sales, on the other hand, were up 25%, standing at £661 million -- that's their highest level of sales ever.

Now, Fund of Funds products have yet to experience a net outflow of funds: funds under management still grew during the quarter. And with £64 billion invested in Fund of Funds products, they considerably out-gun the £43 billion invested in trackers.

But the gap, it seems, is closing.

The light dawns

To me, the messages are simple.

• One: multi-manager Fund of Funds products are becoming yesterday's story. Few deliver on their promise, the charges are eye-watering, and the incentive to sell them is fast disappearing.
• Two: despite a lack of costly promotion and glitzy marketing campaigns, tracker sales are doing well. They now account for 7% of overall funds under management, and cover a wide range of UK, European, Asia Pacific and North American indices.
• Three: the message about charges is getting heard. Indeed, it's pretty much the only reason for investing in trackers, as by definition they won't outperform. But equally, they won't under-deliver through performance-sapping charges.