Hands-on approach

If I were to follow the normal format for answering the question of what is wrong with active fund management, I would probably start by explaining how any number of academic research papers point to the fact that most active fund managers do not consistently beat their benchmark.

I might then go on to explain how these same underperforming fund managers still rake off their annual management charges without a care in the world for their poor, long-suffering investors who have, in many cases, shown incredible patience by remaining invested in funds that they should have got shot of long ago. In fact if I was feeling particularly vindictive, I might also add that many of these managers have recently increased their annual management charges and then allude to the fact that annual management charges do not represent the true costs of investing in a fund.

I could go on to explain that even though the total expense ratio – a measure not always shown on investor factsheets – represents a more honest measure of costs faced by an investor in a fund, but does not include the impact of dealing costs incurred in the day-to-day management of that fund. Here, I might be inclined to refer readers to an old FSA study from 2000, The Price of Retail Investing in the UK, in which the author calculated that where a UK large cap fund has 100 per cent portfolio turnover – that is, sells out of all of its assets in a position and replaces them with other assets within the same year – the additional hidden costs amounted to an additional annual charge of around 1.8 per cent.

Once I had given you the bad news about actively managed funds, I might want to move on to the problems that I see with the rapidly expanding use of discretionary fund managers within the IFA community. I would question the judgement of many IFAs in handing over the investment management responsibility for their hard-won clients to organisations that in many cases, rather worryingly in my mind, either have their own financial planning arms or are in the process of establishing them and how, in the eyes of the client, these discretionary fund managers might be seen to be the most important part of the service they receive.

I might also question the logic of the introduction of yet another layer of charge on the client, especially as we approach an era of unrivalled charge transparency, and could argue with some conviction that it is going to require a significant amount of excess alpha to overcome the impact of all of these charges.

I might then choose to look specifically at the overall costs that a client, in a post retail distribution review, discretionary fund manager-led actively managed investment proposition, might face and could conclude that with a 1 per cent adviser fee, a 0.5 per cent discretionary fund manager fee, a 0.3 per cent wrap fee and a TER of 1.2 per cent in the underlying portfolio – not including the aforementioned dealing costs of course – that it is strange that the adviser, who sources the client, advises the client and takes all the compliance risk, receives only one-third of an overall take from the client of 3 per cent.