Harvey Jones discovers just how many expensive lunches he's been buying the managers of his funds.
Fund managers generally take quite a mauling on The Motley Fool, but I still have at least half my portfolio into their hands. What kind of Fool am I?
The charge against fund managers is that most fail to beat the market, and charge hefty fees for the privilege of institutionalised underperformance. This means that even if the manager does get lucky and beats their index, you can still end up down on the deal.
This makes actively managed funds look a poor bargain, especially when you consider the Fool-friendly alternative, the low-cost index tracker, such as an exchange traded fund (ETF). Trackers guarantee to match the market, with a slight drag from their relatively small charges.
It looks like an open and shut case for the prosecution, so why am I still putting my faith in the accused?
It's a drag
Mostly it is habit. I bought most of the unit trusts over a decade ago, before I started investing in direct equities.
I'm fond of my fund managers, they've been with me a long time, especially my Jupiter funds, which I bought back in the days of PEPs.
I knew enough to buy them through a discount broker, which meant I typically slashed the initial 5.25% charge to 0.25%, and the 1.5% annual charge to 1.25%. But that still makes them more expensive than today's trackers, which have zero upfront charges and a 0.3% annual fee.
Say you put a £10,000 lump sum into an investment fund that subsequently grows 7% a year. After 10 years, you will have £19,671 before any charges have been deducted.
If the fund charges zero upfront and 0.3% annually, your return will fall to £19,127. You will have paid £554 in fees.
But if it charges an initial 0.25% and an annual 1.25%, as most of my funds do, your return will fall to £17,446, with charges totalling £2,225.
Wow.
So even with heavily-discounted fund charges, I still pay £1,671 more for the privilege of active management than using a tracker. It will take a pretty clever fund manager to make up the difference.
It's even worse for most people
And this calculation is generous to fund managers. If you pay an initial 5.25% and annual 1.5% charge, as many do, your original investment immediately shrinks to £9,475, and your 10-year return to £16,184. So you have paid an astonishing £3,487 in charges to your fund manager.
That's only on £10,000 over 10 years. On £100,000, we are looking at £34,879 compared to £5,540 on the tracker -- an extra £29,339.
And over 20 years… enough, I think I've made my point. And I've also taught myself an astonishing lesson.
A long lunch, at my expense
Gosh, these figures have rattled me. I'm checking and re-checking them, to make sure I have got my sums right. But it seems like I'm buying my fund managers an awful lot of lunches.
In fact, I'm tempted to stop the argument right here. When I started writing this piece, I expected to produce a mealy-mouthed conclusion, suggesting that if you can find the right manager, actively managed funds can make a neat counterbalance to your own tracker or shares portfolio.
I'm not going to say that now. I don't want to pay out tens of thousands of pounds in charges over the next 20 or 30 years.
Outnumbered, outgunned
I don't doubt the likes of Neil Woodford and Anthony Nutt have more investment acumen in their toenail clippings than I have in my entire body. That's why people have trusted them with billions. You certainly wouldn't invest your money with me.
But blimey, they don't come cheap. And they are also rarities. The vast majority of fund managers are uninspired foot soldiers who will never make up for their excessive fees.
Many don't even try, saving their faces by following the notorious practice of benchmarking, replicating an index just like a tracker, but at far greater cost. That makes you a guaranteed loser.
Their true genius is in lining their own pockets, not yours.
Philip Gibbs rocks!
If fund managers struggle to outperform in the good times, they don't offer much protection in the bad either.
My portfolio of funds took a right hammering after last year's crash, and don't even get me started on the aftermath of the technology boom. Although to be fair, some of the better funds did offer ballast that wasn't present in my direct equity portfolio.
Neil Woodford at Invesco Perpetual Income took some of the edge off the recent collapse, while Philip Gibbs at Jupiter Financial Opportunities avoided last autumn's crash altogether, and was making money instead. I'll happily pay for some of that.
But most of funds in my portfolio show a depressing mediocrity, tracking up and down in line with their benchmark index.
And I'm paying how much for that?
Don't get mad, get rid
But what's the alternative? Trackers, of course, and as a happy investor in the iShares FTSE 100 tracker, I'm certainly a fan.
I also plan to have plenty fun of investing in direct equities, with none of the annual charges of investing in funds.
It is not often I start an article pursuing one angle, then completely talk myself out of it. But those sums have thoroughly changed my strategy.
I was naïve before, but now I really am blown away.
With one or two honourable exceptions, now is the time to start the terminating my portfolio of funds. With extreme prejudice.
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