“Don’t just do something, stand there,” said former US president Ronald Reagan. It’s advice investors should take on board. Research from FE Trustnet shows that fund managers who change their holdings often, underperform those who don’t. The research group compared returns from the 10% of funds with the highest security turnover with the 10% of funds with the lowest across three fund styles over the last year. Across balanced managed, actively managed and cautious managed funds, those that churn their investments most frequently, were the worst performers. On average, returns were 0.81% smaller per year. On a decent sum invested over several years, that adds up.
The main reason for the difference? Cost. Funds that chop and change their portfolio holdings more frequently rack up higher trading costs. These often act as ‘hidden fees’. That’s because annual charges and expense ratios often don’t cover the brokerage fees or stamp duty incurred when a fund buys or sells a holding. Yet as David Norman, head ofTCF Investment, told the FT, because each trade costs around 1% they have a big impact on the total cost. For example, Norman claims excessive portfolio turnover can add 0.9% to a total expense ratio (TER) that is supposedly only 1.6%.
The scary thing is that high portfolio turnover is on the increase, says Tim Cockerill on Trustnet. “The average period for holding a stock has fallen considerably and is now approximatelynine months, whereas back in the mid-1960s it was nearly eight years.”
The change is partly down to increasing numbers of day traders, who quickly trade in and out of stocks. The use of computer programs to buy and sell shares quickly to take advantages of small movements in price is also a factor. A short-term culture among fund managers and investors is another reason, says Cockerill. “Pressure to perform in the short term comes from within management groups. Remuneration is frequently linked to short-term performance.” Investors are also to blame as their “short-term focus on performance puts pressure on management teams… to deliver positive short-term news”.
It’s not easy for retail investors to judge the impact of trading on performance as few data are published. Choosing a manager who has a long-term investing style helps. For example, MoneyWeek favourite Neil Woodford’s Invesco Perpetual Income has an average holding period of more than five years. Or stick to exchange-traded funds with low TERs.