“A good test of a chef is to see if he eats his own cooking,” says William Hutchings in Financial News. “Some investors wonder if this could be extended to the asset management industry, requiring managers to invest in the funds they manage.”
The sad fact is that most fund managers are probably quite happy not to put their own hard-earned cash into the funds they manage, because most of them fail to outperform the market over any decent length of time. And one very obvious reason for this is the chunky fees they slap on to them.
Fund managers aren’t the most transparent when it comes to fees. But if you take into account everything from the annual management fee to what it costs to market the fund, you’re left with the Total Expense Ratio (TER).
According to Lipper Fitzrovia, the average TER on equity funds in 2005 was 0.92% in the US, and 1.68% in Britain. It may not sound much, but as Tom Burroughes of The Business says, “a £10,000 fund investment that grows by 7% a year will reach a value of £17,908 after ten years and £32,071 after 20 years when the TER is 1%. But a TER of 2% would cut the investment to £16,289 and £26,533 respectively.”
So once you take these fees into account, how many funds are actually beating the market? Very few, it would seem. According to research from Morningstar, 47% of the cheapest US funds succeeded in outperforming the average for their sectors over ten years. But when it came to the most costly, only 19% did. It seems it pays to go for cheaper funds and ignore actively-managed funds altogether.
Indeed, figures from John Bogle of Vanguard show that over the 25 years from 1980 to 2005, the S&P 500 index returned an average of 12.3% a year, reports The Economist, against 10% for the average equity fund. “It is like guessing the weight of a cow,” says Ian Shipway of Thinc Group in The Independent. “The aggregate opinion of a large number is far more likely to be accurate than the opinion of one individual.” And that is why you may be far better off putting your money into an exchange-traded fund (ETF), which simply tracks the performance of a particular index.
Anna Bowes of AWD Chase de Vere says the key to picking one is to base your decision on their cost. That’s why, for those who want to follow UK stocks, she likes the Fidelity MoneyBuilder UK Index Fund, which has a very low annual management charge of around 0.1%. If, like us, you are less than excited about the prospects for the UK market, you can learn more about some of the ETFs we prefer in the Isa supplement free with this issue.