I did some financial exams just before Christmas. One of the questions in the essay section was: “‘One of the most important elements in choosing a fund should be the level of charges and other expenses.’ Critically assess this statement.”
As regular readers will know, we have been critically assessing this statement in MoneyWeek for over a decade. Sometimes life is kind. However, while I think you know how we feel about charges (and I’m pleased to say that the examiners appear to agree with us), it is a subject worth revisiting – given it’s now only a matter of days until those who want to use their full individual savings account (Isa) allowance for this year need to have moved the cash into their wrappers. Once that’s done, they’ll want to start thinking about where that cash goes.
We’ve got some good ideas for you on this in the magazine (see our Roundtable). But as you wander the investment universe with your £11,600, try not to commit to anything until you have looked back to a note, referenced by Peter Bennett of Walker Crips this week, but originally written in 1997 by the kings of the low-cost tracking business, Vanguard.
In it, they showed the effects of total costs of 2.5% a year – around what the average unit trust still costs once trading commissions and the like are included – on £10,000 invested for 40 years at a growth rate of 10%. If you had been able to invest the money cost-free in the index, you’d have ended up with £452,600. In the fund? £180,000. Of the return, 62% is “trousered” by the fund manager. It is, as Bennett says, “jawdropping”.
But it’s worse than even these figures suggest. Why? Because most funds don’t even do as well as the index. Over the average five-year period, just 25% of fund managers beat their chosen benchmark. So, to be clear, 75% of them merely meet the performance of their index, or underperform it.
This doesn’t mean you shouldn’t buy active funds – there are good arguments to be made to suggest that, particularly in low-return environments such as ours, good managers are worth seeking out. But it does mean you should look at costs and structures carefully before you buy anything this year.
Do so, and as the model answer from my exam (see Cisi.org) notes, the evidence would “generally be critical of hedge funds and insurance bonds” and would “favour investment trusts relative to unit trusts”.
Our model portfolio of investment trusts is available here. I would also draw your attention to the closed-end funds mentioned by David C Stevenson and to the Witan Investment Trust, which recently announced its 38th consecutive dividend rise; returned over 15% last year; is reasonably priced (the total expense ratio is 0.69% although there are performance fees); and still sees its shares trading at an 11% discount to their net asset value.