Europeans Consent To Investment Costs Rip-Off
Written by: John Authers ("Financial Times")
19 May 2013
Categories – Index Tracking
John Authers wrote in last weekend`s Financial Times that Americans now have a better deal from their investment managers than Europeans, as managers charge more in Europe and are less transparent with their costs.
Americans have learnt two key lessons from the past two decades. First, chasing past strong performers is a mug`s game. Second, low costs are vital to overall returns, and managers who have maintained low costs in the past tend to maintain that culture in the future. This has led to a change of behaviour in the US.
In the 1990s, the 32.5% of funds carrying the Morningstar research agency`s highest four- and five-star ratings accounted for more than 80% of the money that gushed into stock markets in that period. Performance-chasing is natural, but usually self-defeating. Top performers have usually done well by making a specific bet, or benefiting from the cycle, which will correct itself.
Americans have learnt from the great equity boom and now seek out the cheapest funds. Equity funds held by US investors now charge an average of 0.64% p.a., down from 0.93% p.a. a decade earlier. This makes a big difference in an environment of low returns. The vogue for passive index mutual funds and ETFs with relatively low costs is the main driver – these vehicles holding 34% of all assets (up from 18% a decade ago).
There is no corresponding trend to speak of in Europe. Barely 10% of European assets are managed for less than 0.5% p.a.; moreover, in excess of 60% of assets are managed at a cost of 1% p.a. or more.
European fund managers, led by bancassurers on the continent and commission-charging brokers in the UK still offer a bad deal. Sadly, consumers do not know enough to look for these costs and punish those that charge excessively.
“Beware, Charges Can Wipe Out Your Gains”
Written by: Terry Smith ("Financial Times")
28 April 2013
Categories – Index Tracking
In Part 5 of his excellent series in the FT Weekend, Terry Smith focussed upon the costs associated with investment. He makes the point that, even if you run a concentrated portfolio of quality shares, your returns will be constrained if you fail to control costs; many investors are unaware of how much they are being charged for their investment activity.
Financial advisers and wealth managers typically charge fees of 0.5-1.0% per cent on the value of the portfolio, and will then use an investment platform to hold individual funds or shares, which might cost another 0.25% per cent a year.
If the investments are held in mutual funds (unit trusts, OEICs, etc.), there will be an annual management charge of 0.75-1.5% per cent. In addition, the funds charge certain expenses to the fund: custody, administration, legal and marketing expenses – all of which equate to what used to be known as the Total Expenses Ratio (now known as the Ongoing Charges Figure). This is typically 1.0-1.75 per cent but, once platform and advice costs are added in, the running total is generally between 1.75 and 3 per cent.
Even that isn`t it. There is also the hidden cost of dealing within the fund. When a fund manager or an investor deals in stocks, he or she pays commissions, stamp duty at 0.5 per cent.
Data published in an FSA study suggested that the average UK fund manager turned over about four fifths of a portfolio each year. Apart from the questions this raises about the lack of conviction and hyperactivity, it would suggest that additional undisclosed costs of up to 1.4 per cent are being incurred each year on top of the “total” expense ratio.
Terry Smith remarks that these costs are in stark contrast to the income available from bonds and equities. The yield on the FTSE 100 is 3.8 per cent, on the S&P 500 it is 2.1 per cent and 10 year government bonds in the UK and US yield significantly under 2 per cent. In other words, more than 100 per cent of the expected income on portfolios is being absorbed by charges.
This is disguised by the fact that almost all income funds apply such charges to the capital value of the fund, and not as a deduction from income.
According to John Bogle, the founder of Vanguard, during the 81 years to 2007, reinvested dividend income accounted for approximately 95 per cent of the compound long-term return earned by the companies in the S&P 500. No one can afford to throw away the income from their portfolio on charges.
How do you avoid or reduce charges? - one way is to cut out as many of the layers of intermediation as you can between you and the actual stocks which you own. The other method is to buy an index fund, which just tracks an index.
Given that the average active fund manager under-performs the benchmark index anyway, why would you pay more?
High Costs Leave Managed Funds Without A Defence
Written by: John Authers ("Financial Times")
7 April 2013
Categories – Index Tracking
John Authers wrote in last weekend`s Financial Times that traditional actively managed mutual funds are obsolete and it was futile to defend the indefensible. Yet attempts to point out the blatant superiority of newer passive investment products provoke furious defences from brokers.
Authers claims that the arguments of intermediaries are so threadbare that they can only be motivated by a desire to keep the commissions coming. But they are a formidable obstacle to needed change and this matters.
His main concern is that, following a strong rally, the five year returns of shares may look very good come the fifth anniversary of Lehman by September 2013 and this will make it easier to camouflage excessive costs – and to avert the deep shake-up that the fund management industry needs.
He characterises the active fund managers` model as an attempt to beat market indices with a portfolio of about 100 stocks. Such diversification makes it hard to beat the market. And while many managers are smart enough to beat the market, they cannot do so and at the same time pay themselves decently.
Authers goes on to refer to a recent survey by the London investment consultancy, Style Research, examining how 425 global equity funds, benchmarked against the MSCI World Index, performed last year. Without costs, 59% of them beat the index. Once costs to investors were included, only 31% beat the index (i.e. 28% charged too much to allow clients also to beat the index).
He states that the best answer yet devised to reduce costs is for brokers to offer index funds but, as these do not pay commission, “this spurs brokers` ire”. The arguments of the brokers are:
- First, active managers can take evasive action in a market dive – specious, as active managers under-perform consistently throughout bull and bear markets. According to Morningstar over the past 5 years, 61% of balanced funds and 67% of US equity funds failed to match their index. Moreover, they are paid to pick stocks, not time the market.
- Second, index funds are guaranteed to lose to the index, thanks to their costs – true, but again specious. The odds are they will perform better than their active counterparts, as well as enjoy economies of scale.
- Third, choosing index funds entails ignoring active managers who consistently outperform, but this small band may be the exactly the ones to avoid as history shows that persistent out-performance attracts inflows, which increases costs and makes it harder to outperform.
John Authers concludes by saying that the current modus operandi of active managers burdens investors with too many costs and this has to change.
Clean Fee Class Cost Revelations Could Benefit Passives
Written by: John Lappin ("FT Adviser")
4 March 2013
Categories – Index Tracking
Writing in the FT Adviser, John Lappin suggests that the likes of Vanguard, Blackrock, SCM Private and TCF Investment may well find themselves at even more of a price advantage than they expected. This is partly because FundsNetwork has recently expressed its surprise at the fact that the level of “clean” actively-managed fund charges has not drifted down to the expected level.
Although “clean” never necessarily meant cheap, there was an expectation that fund charges would fall more because the part of the management charge devoted to commission, and perhaps the basis points paid to a platform or life office, would be stripped out.
Asking the reasons for this, Lappin speculates whether active fund houses are anticipating an increased administrative burden, or levying more to pay for direct advertising and consumer campaigns. Whatever the reason, it may lay bare the cost and value of active fund management. Although evidence is only anecdotal at this stage, Lappin concludes with the view:
“But if active players are pushing up prices, they risk not only the wrath of the regulator, they may hand a market advantage to their passive rivals just as the regulations have already given them a massive boost.”
Welcome Signs of Glasnost on Fund Charges
Written by: Jonathan Eley ("Financial Times")
10 February 2012
Categories – Index Tracking
In last weekend`s F.T., Jonathan Eley observed that detente appeared to be breaking out between those who wanted better disclosure about fund costs and the Investment Management Association (IMA), the respective players being Gina Miller and Daniel Godfrey. As the newish CEO of the IMA, Daniel Godfrey has been making more conciliatory statements: “We need a clear and trusted (cost) number” – along the lines of what Gina and Alan Miller of the True and Fair Campaign have been lobbying for since 2009.
Eley makes the point that Godfrey is moving the same way as the regulators by adopting this stance, given that the FSA is currently probing annuity business and the OFT has launched a study into the cost of workplace pensions.
Furthermore, consumers are becoming increasingly aware of charges, following the introduction of the Retail Distribution Review, particularly that around half a fund`s annual management charge is paid away to platforms and advisers. He states that “clean” share classes are gradually becoming more widely available on platforms, as are full commission rebates.
Mr Eley then makes reference to the “relentless rise of passive investments, particularly exchange traded funds (ETFs)”, the main selling point of which is their low cost. He finishes his article by stating that three of the world`s leading academic authorities (Dimson, Marsh and Staunton) believe that prospective real returns for world equities, which have averaged 4.15 per annum since 1900, will in future fall within the range 3.0% – 3.5% p.a. in real terms. Therefore, if average market returns are going to be structurally lower, there is even more incentive to keep the costs of investing lower (one of the few things an investor can control).