Cost is an important factor in the generation of investment returns – this much is beyond dispute.
Fund fees are always going to be a drag on performance and so lower charges will help to improve aggregate returns. The good news then is that the costs of investment management are falling and the regulatory backdrop is supportive of this trend.
The bad news is that investors may now be inclined to focus too much on costs, and in so doing lose sight of another vital consideration – what constitutes genuine value for money. The issue of cost versus value is arguably at its starkest whenever the relative merits of active and passive investing are being debated, but it extends much further than that.
There is a sense in many quarters that lower costs are automatically and unquestionably a good thing, while higher costs are undeniably bad. We would take issue with this view. After all, the studies extolling the benefits of passive over active look at sector average fund performance, and clearly we, as others, are not paid to buy the average.
There are plenty of instances of this within our portfolios – for example, Old Mutual fund manager Luke Kerr has returned 110.5 per cent over the five years to April 2016, compared with the FTSE All-Share index’s rise of just 8.1 per cent in the same period.
Focusing solely on costs will often condemn an investor to low growth and will almost certainly remove any chance of ever identifying the superstars.
Cheap beta has its place and we are very happy to make use of passive funds in a number of our portfolios. However, one of the few certainties in investment is that no matter how low they may be, the fees charged by a passive fund mean it will always underperform its benchmark.
On a related point, we have heard some people suggesting they put money into passive funds because it is so difficult to choose active ones – as if the former somehow relieves investors of the responsibility of making a decision. Yet we would strongly argue the same care and thought should go into the selection of a passive fund as an active one.
Regardless of what the name suggests, the selection of a passive vehicle requires an active decision on the part of the investor. If they buy a FTSE All-Share tracker, they are still introducing a number of biases into their portfolio that need to be properly weighed up. For example, are they comfortable with a near-25 per cent weighting to financials, or – after the heavy falls of recent years – with what amounts to a 10 per cent allocation to oil and gas?
All markets have inherent biases that reflect the nature and shape of the firms that choose to list there. There will be times when investors will be happy to be exposed to the high technology content of the US stockmarket – but there will also be times when that could prove extremely painful.
The key issue here, both for investors and for fund managers, is whether they truly want to gravitate towards the lowest common denominator. We would strongly challenge anyone who maintains active managers cannot outperform index-tracker funds over the longer term, and we believe the idea that cost should be the primary consideration is simply wrong.
Paying a little more for exceptional asset managers can help investors reap rewards over time.
Gary Potter is co-head of multi-manager at F&C Investments
