There’s no stopping the active fund management community shooting itself in the foot. Just when Jupiter Asset Management was showing all the signs of becoming a ‘born again’ Perpetual, the departure of John Duffield, the CEO, together with a number of other senior directors and fund managers, has thrown the whole business into a tailspin.

But hang on a minute. Why should anyone worry about Jupiter? It’s happening all the time. Scottish Widows lost an entire team of European managers and a huge amount of publicity surrounded Nicola Horlick’s defection from Mercury Asset Management not so long ago. We should therefore spare a thought for all those diligent investors who have been sucked in over the years on the strength of glowing performance results advertised so prominently in newspapers and billboards. They face the difficult decision of whether to stay where they are and put their faith in the new management’s ability to continue where the others left off. The alternative is to move to new pastures where there is a team already in situ with a demonstrable record of success. In other words the choice requires an act of faith on behalf of the investor or, else cough up with the cost of moving.

And an act of faith it really is. Jupiter’s flagship fund, the Jupiter Income Fund, has plummeted to 88^th position out of 91 equity income funds since Stephen Littlewood, the star fund manager left the company at the start of the year.

This disruption at Jupiter brings into sharp focus just one of the many risks which investors unwittingly take when they choose an active fund manager to invest their hard earned savings. And these upheavals are not uncommon. The worrying point to note is that it seems there is no limit to the price management puts on retaining star fund managers. If management lobs out £1 million and more to buy star fund manager loyalty, the game of musical chairs will go on and on because vast sums like this must surely give an over-inflated opinion of their worth as fund managers. And who benefits? The fund manager, the headhunter and estate agent! All at the expense of the investor.

The fact of the matter is that the value which active fund managers add to portfolio returns in return for high fees and charges is suspect to say the least. The following is just one of the principal findings by Professor Simon Keane of Glasgow University who was commissioned by Virgin Direct to examine the notion that active fund managers justify their high fees:

"Professionally managed funds fail to exhibit better stock-picking ability than can be accounted for by chance. This is not to say that active funds cannot earn abnormal returns, simply that, because of their operating costs, the balance of probabilities at the point of decision-making is that they will fail to match the index"

If operating costs prevent active fund managers from delivering their promise of above average returns, the huge salaries paid to so-called ‘star fund managers’ is hardly the way to tackle the problem.

Tracker fund managers see high salaries as the ultimate folly and the reason why tracker funds deserve to gain popular appeal. ‘Fat cat’ salaries not only drive up charges and so drag down performance, but they also perpetuate a culture of greed. This simply exacerbates the problem by keeping managers on the move in search of higher salaries. And what is worse news for the investor, each time a fund manager moves, the fund performance is further undermined by the costs incurred as the new incumbent rebuilds the portfolio to his or her taste.

It’s obvious that investors bear the brunt of dwindling performance, but to add insult to injury they are often encouraged to go in search of other active funds in the hope they will make up the lost ground. This often makes matters worse. The funds they choose will almost inevitably be those which catch the eye - the ones which top the performance tables usually over periods of less than 10 years which Professor Keane regards as statistically meaningless. What is statistically meaningful is the high probability that the fund manager of the chosen ‘top performing’ fund will move to manage funds elsewhere and so leave the investor right back at the start.

The investor could, of course, choose an index tracker fund. Tracker funds are certainly attracting more and more investors in the UK but nothing on the scale of the US where the tracker fund market is further advanced and nearly 40% of Mutual Fund sales went to tracker funds last year. In a recent update of his book, A Random Walk Down Wall Street, (Available at the netISA Bookshop) Burton G. Malkeil calculated that since he first recommended tracker funds 30 years ago, a Wall Street tracker mutual fund had turned an initial investment of $10,000 into $311,000 compared with $172,000 for the typical active general equity fund. And in the UK the picture is the same.

The figures below may surprise you. They cover ALL UK invested Unit Trusts and show how few actually managed to beat the FTSE 100 Index.

More recent figures show that just one in three unit trusts managed to outperform their benchmark index in the year to the end of December 1999. This poor record is actually an improvement on the year to September 1999 when just 1 in 4 beat their benchmark index. (Source HSBC Asset Management).

If the evidence in favour of tracker funds is so convincing, why haven’t UK investors shunned active funds in their hoards? Actually in the institutional pensions market tracker funds have won widespread approval but it is in the retail (private investor) sector where tracker funds have yet to make their mark. There are many reasons for this but underlying them all is the general belief that tracker funds are for beginners. Culturally none of us like to be cast in the role of the inexperienced investor. But there are other reasons which have prevented tracker funds from gaining the level of popular appeal achieved in the US.

One of the toughest obstacles preventing tracker funds from gaining popularity is the powerful vested interests in promoting active fund management. The entire securities industry hinges on the existence of a healthy thriving fund management community and hence investment institutions are bent on advertising their successes which reinforces the belief that they possess superior investment skills. These powerful vested interests are therefore quick to denigrate trackers because they represent a very real threat to the continued profitability of their businesses.

The fund management community also has a great champion in the IFA who plays a key part in funds distribution. IFAs’ attitude towards trackers is not so much hostile as ambivalent and, of course, active fund managers are hardly likely to encourage IFAs to choose trackers in preference to their high cost active funds. A further shift towards fee-based remuneration will do much to improve the quality of advice because IFAs can then make recommendations based on the reliability and consistency of prospective investment returns rather than the amount of commission that is paid. Boosting the attractions of tracker funds is very much on the Government’s agenda because most of the tax breaks the Revenue gives ISA and Pension fund investors ends up in the back pockets of expensive active fund managers. Unfortunately the Government does nothing to encourage the fee system but one simple measure they could take is the removal of the 17½% VAT penalty applying to fees and not commission. A modest change like this would make a huge contribution to improving the personal savings landscape for the benefit of savers.

Although the press has started giving the active fund managers a hard time, they still mislead readers into believing that tracker funds are for novices. This opening paragraph appeared in a serious article about tracker funds in a leading national newspaper.

Nothing was mentioned in the article about the risk control features of trackers nor about the luck that active fund managers require to beat their benchmark index.

At least the article could have mentioned that with a tracker you aren’t faced with the problem of the ‘black box’ getting up and walking off for a bigger salary. The time is now well overdue for investors in actively managed funds to make their voice heard in matters like fund management defections. They should make it clear that active fund managers can no longer rely on their inertia and indifference to give them time to put their house in order at the investors’ expense. High fees and charges are unacceptable because they perpetuate the gravy train.

Wake up, investors! It’s time to get on the right track.

Post Script. The pay-out which the high profile Jupiter defectors received for leaving their customers in the lurch was more than £ ½ billion.