News

24 January 2020

What is the value fund managers actually add?

Suppose that you need to rent a car for the weekend, but you can’t find a rental company able to guarantee the kind of vehicle you are going to get. You could be given anything from a Citroen C1 to a Mercedes A class, and you won’t know what it’s going to be until you show up to collect the keys.

While this scenario might be disconcerting, at least choosing which firm to use should be straightforward. All else being equal, you will go with whoever charges you the lowest fee.

This is common sense, since none of them are certain of what they will be able to deliver. There is no point in paying more if you can’t be sure that you are going to receive the extra value for that money.

Yet, this is how the fund management industry has worked for decades. Active managers have been charging high fees for their products even though there is no way anybody can be sure of the outcomes that they are going to be able to produce.

What are active managers selling?

The rationale for this is that active managers offer the potential to out-perform the market. That’s their selling point – you pay more because active management is the only way that your money can grow ahead of the benchmark. This is the reason so many investors and advisers fret over performance tables and fund ratings.

However, every genuine fund manager in the world is very careful to point out that not only is past performance no indicator of future returns, but that no level of performance is ever guaranteed. Given the vagaries of the market, it is simply impossible for anybody to know how any fund is going to perform in the future.

This hasn’t, however, stopped active managers from promoting above average returns as their unique selling point. It’s what almost every active manager in the world strives to deliver.

The irony, of course, is that this is obviously unobtainable. It’s impossible for every active fund to be better than average. Simple mathematics dictates that not all managers can be above average. In fact, half of them will be below average.

What does the evidence show?

As an increasing amount of research shows, most active fund managers – when compared to the market they benchmark themselves against – underperform.

The most recent S&P Indices Versus Active (SPIVA) scorecard shows that over the 10 years to the end of June 2019, only 25.66% of UK equity funds out-performed the S&P United Kingdom BMI. In other words, just under three-quarters did not.

SPIVA scorecards calculated in markets around the world all show similar patterns. So too does Morningstar’s Active/Passive Barometer.

Although it is only calculated for the US market, the most recent Morningstar barometer shows that only 23% of all active funds in the US beat the average of passive funds over the past decade. For US Large Blend Equity Funds, the figure is only 8%.

Where is the value for money?

Given this success rate, it should be obvious to active managers that what they are selling is not deliverable. It is much like a car rental company charging you for a Mercedes A class, even though it can’t be sure that you will actually be given one. A company that did that would surely find itself out of business fairly quickly.

Yet, active fund managers continue to sell the idea of out-performance, even though more and more investors and advisers have begun to understand the research — that beating the market is extremely difficult to do, and improbable over the long term.

That is why there is now more money invested in passive funds than in active funds in the US. That milestone was reached in August last year.

Investors and advisers appreciate that the value proposition of index tracking funds is one that can actually be delivered consistently — to produce the return of the market, minus a very small fee. It’s understandable, straightforward, and reliable.

It is like the comfort of going to a car rental company and being given the keys of the vehicle that you actually booked. You should, after all, get what you pay for.

The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest.

This communication is for general information only and is not intended to be individual advice. It represents our understanding of law and HM Revenue & Customs practice. You are recommended to seek competent professional advice before taking any action.

Tax and Estate Planning Services are not regulated by the Financial Conduct Authority.

Contact us today...

We have offices in Edinburgh, Glasgow, Aberdeen, Perth and London. You can contact us at any of our offices, or by email.

Carbon Financial Partners Limited is authorised and regulated by the Financial Conduct Authority. The guidance and/or advice contained in this website is subject to UK regulatory regime and is therefore restricted to consumers based in the UK.

The Financial Conduct Authority does not regulate some forms of tax advice.
Registered in Scotland #SC386400.
Registered Office: 61 Manor Place, Edinburgh EH3 7EG, Scotland.
© Carbon Financial Partners 2020
www.financial-ombudsman.org.uk

Client Account | Personal Finance Portal | Privacy Notice | Cookies

Site designed and developed by Art Department