The battle between higher-cost and lower-cost fund management has dragged on for many a decade.
However, over three years, a timeframe used by many investors to assess performance, the UK stockmarket has gone up roughly 50 per cent, with the FTSE All Share index moving from 1,897 points on March 13 2009 to 3,093 points on March 13 2012, albeit with extreme volatility. As investors in funds that tracked the index cheaply would have achieved a healthy return, the question is whether higher-cost managers have delivered much extra.
Using data from Morningstar on funds’ performance and total expense ratios (TERs), Investment Adviser split the Mixed Investment 40-85 per cent Shares sector into those funds with a TER above 2 per cent, compared with a sector average of 1.71 per cent, and those below. We then calculated how many of the higher TER funds were in the bottom quartile – 89th out of 117 or below – of the sector in terms of their performance over three years to March 13.
Of the 144 funds in the sector with a TER, a third have a TER of more than 2 per cent. The results showed that 16 out of the 29 fourth quartile funds had TERs of more than 2 per cent, with the £221.3m CF Miton Strategic Portfolio ranking last with a return of 20.14 per cent and a TER of 2.13 per cent. Other funds in this category include the £91.8m Insight Investment Wealth Builder Balanced, the £96.3m Thames River Balanced Managed and the £14.7m PSigma Dynamic Multi-Asset funds.
Meanwhile, the top 16 best performing funds with a TER of less than 2 per cent were all ranked within the top 20 of the sector, with the £599.7m Aberdeen Multi-Asset fund topping the list with a return of 68.9 per cent and a TER of 1.57 per cent.
However, also included among the best performers is the £226.1m CF Midas Balanced Growth fund, which is ranked sixth with a return of 65.41 per cent and a TER of approximately 1.74 per cent.
Mark Harper, head of marketing at Mam Funds, which runs both the CF Miton Strategic Portfolio and the CF Midas Balanced Growth vehicles, says one of the explanations for the gap between the TERs is the Strategic fund is a pure fund of funds, while the Balanced Growth fund holds financial instruments directly alongside funds.
However, he adds, when comparing the performance and TER of funds in the sector, it depends on the time period in question, as over five years the CF Miton Strategic Portfolio is ranked sixth out of 94 funds in the sector with a return of 33.04 per cent.
“Depending on the time period there is an equal argument to say, actually, it is a value for money fund in relation to its TER. It is all part of what the fund is trying to do, which is trying to protect on the downside and get an incremental return over the long term, and I think that’s borne out by the longer term performance.
“We would rather stay fourth quartile in a rising market than fourth quartile in a falling market. Sometimes it looks better than others, but over the long term we’re obviously content about how the fund is doing. It’s positioned at the more cautious end of the market, albeit in the [former] balanced sector.”
In contrast, the Balanced Growth fund has slightly more volatility, and has performed well in the bull market in the past three years, but over a five year period the situation is partially reversed with the lower cost fund ranked 89th in the sector with a loss of 3.23 per cent. Mr Harper observes: “They sit in the same sector but different funds are trying to do different things, so therefore, they should be judged against what they’re trying to do.”
Insight Investment, whose Wealth Builder Balanced fund fell into the fourth-quartile, higher-TER category over three years, agrees the time period in question is important, but notes that following a complete restructure of its multi-asset funds in the first quarter of 2009, its focus is on delivering returns through a disciplined management of risk.
A spokesperson adds: “Elsewhere in the sector, many portfolios were running substantially more risk, and while we did lag peers, we also delivered a 33 per cent gain for investors. We aim to create diverse, multi-asset portfolios which can stand up to market volatility. As part of the overall portfolio construction we do consider costs carefully, and only make investments in active funds where we believe there is a genuine case for alpha [or outperformance].”
Tom Becket, managing director of PSigma Investment Management and manager of the PSigma Dynamic Multi Asset fund, notes the ranking of the fund in the sector is not that much of a surprise as the portfolio has a maximum of 50 per cent in equities, so will naturally underperform its peers with higher equity content in rising markets.
“That’s something that we’re totally comfortable with,” explains Mr Becket. “It’s something we hope the investors in the fund understand, something we’ve tried to educate people about, so absolutely on a relative basis it looks poor, but if you look at it in terms of risk adjusted return – the returns we delivered on the upside relative to the amount of risk we’re taking, particularly equity risk – then we’re much more comfortable.
“We try and have at least eight but up to 12 different asset classes within the portfolio. Equities would be roughly 45 per cent, so we don’t want to be too dominant with regards to equities. We carry on with our strategy and our philosophy and the multi-asset approach really regardless of where we come in the sector that we’re housed in.”
In addition with a fund of less than £20m he points out the current TER of approximately 2.61 per cent could fall as the fund grows.
“We would hope that if people buy into our concept of a multi-asset approach and delivering good risk adjusted returns, that people will invest in the fund and then the TER will come down. We don’t trade necessarily more than anyone else, and we have used exchange traded funds for market timings and things like that which are cheaper than using active funds. We definitely have a strong focus on cost but that’s just the way it is at this point.”
Passive vs active
Gary Potter, co-manager of the Thames River Balanced Managed Fund, points out 2011 was particularly bad for equity markets, and most investors suffered unless they were in sterling assets or gilts. “There’s no question it certainly wasn’t one of our better years – that’s because our portfolio objective is to diversify assets into international markets.”
But he argues even a lower cost passive fund invested in emerging markets, for instance, would not have done particularly well in 2011, as emerging markets fell more than other markets.
“The cost side of the balance sheet here doesn’t necessarily mean that passives were better than active because active was charging more and didn’t do very well. If the strategy in your balanced fund was passive but in overseas markets, then you had a damn tough time as well.
“Yes, active manager fees, TERs were certainly a drag last year, but look at the longer term – three, five or 10 years. In a normalising market you start to see the benefit. We haven’t really changed our view about the managers we have, we still have them all in our portfolio and they’re working very well again.
“Of course we’re working hard to keep our TERs under control but it’s our management fee and those of the underlying funds we’re using. We’ve also got to remember that currently within the body of the TER is the distribution cost. So bring on unbundled fees, because the debate is about what is worth it for what you pay, and our TER is compared with a FTSE All Share tracker, but the tracker doesn’t have a distribution fee, so it’s apples and pears. The devil is in the detail.”
However, regardless of the arguments from more expensive active managers, there will always be those who are committed to cheaper passive investing.
Dennis Hall, managing director of Yellowtail Financial Planning, adds: “We believe the evidence shows that active management rarely delivers the desired outcomes, and the investor pays for it in two ways, increased management costs, which are a drag on performance, and poor performance. Clearly there are some managers who have produced better than average (or index) returns, but generally only when viewed over the long term, with many periods of underperformance along the way.”
Nyree Stewart is deputy features editor at Investment Adviser
