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The Tables are turning in favour of tracker funds
By Richard Carswell
of
trackerfunds.com
February 2002
The Financial Services Authority,
Britain’s City watchdog, has dropped a bombshell that’s sure to
send shockwaves throughout the fund management industry. This could be
the kick-start that tracker funds have been yearning for in their push
for greater acceptance by the general public of funds that aim to
mirror stock market performance and which charge a fraction of the
normal costs.
This bombshell is the publication of a new
website www.fsa.gov.uk/tables
where savers and investors can compare the cost of investment in ISAs.
Dubbed the "League Tables" by the Chancellor of the
Exchequer, Gordon Brown, they are significant in two important ways:
- The express in pure cash terms the
effect of charges and other deductions from regular and lump sum
contributions to a UK Growth ISA.
- The website deliberately excludes
any reference to past performance data.
No surprises about charges and other
deductions
It is hardly surprising that the
League Tables place tracker funds right at the top of the list for
best value for money. What is alarming, though, is the difference in
costs over 10 years of investment between the cheapest and the most
expensive. Jupiter UK Growth charges £2,663, compared with
the lowest cost comparable index tracker fund, which charges only £333.
Jupiter has for some
time been regarded as a rising star but their performance in the
future will need to be meteoric to make up for the cost.
Leading advisors and the fund
managers who pay their commission out of the high charges have been
quick to denounce the FSA’s decision to exclude past performance
data form the League Tables. But they are on a sticky wicket.
The
Jupiter fund underperformed the
lowest cost comparable index tracker
fund in every period
over the last 1, 3, 6 and 12 months to 12th October 2001.
(Source: Standard & Poor’s Fund Services).
Trackerfunds.com has long been
arguing that past performance data should be banned from all
advertisements and that a warning clause should be imposed that draws
attention to the true cost of charges.
If active fund managers are starting
to feel paranoid about this latest move by the FSA they should be.
Professor Simon Keane, who is Professor of Economics at Glasgow
University, published a study into the contribution that active fund
managers make to investment returns. It concluded:
"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
probability at the point of decision-making is that they will fail to
match the index"
If this is correct Active Fund
managers have been luring the trusting and unsuspecting general public
by using past performance records which are based on nothing more than
pure chance. And now it seems that the FSA agrees. To quote from their
League Tables Website:
"When we were putting the tables
together we thought about including past performance information, but
concluded that the link between past and future performance was too
weak to justify including it in our tables."
In response to the inevitable howls
and squeals from the active fund management industry the FSA has
announced a consultation exercise next year to set new rules aimed at
simplifying the use of performance in publicity material to protect
private investors.
But it is almost certain that if the
City Watchdog is so concerned that past performance is misleading, you
can be sure that the new future rules will turn the tables in favour
of tracker funds competing on equal terms with active funds.
Richard
Carswell, Managing Director, Trackerfunds.com
Choose tracker funds to avoid paying the
'fat cats'
Tracker funds have a simple strategy,
one that even the novice investor readily understands, and yet of
every £10 invested in unit trusts currently only 50p is invested in
tracker funds. In the US things are quite different. Last year over
30% of new money went to Mutual Funds – the US equivalent of unit
trusts. More encouraging is that the WM Company reported that pension
funds channel as much as 30% to index tracking managers. One suspects
that the legal sanctions resulting from under-performance are so
serious that pension fund trustees are taking more seriously their
research to find the best funds in which to invest pensioners hard
earned savings – hence the switch to tracker funds.
So what is good for the goose must
surely be good for the gander. But the fact is UK private investors
apparently shun tracker funds. Why?
The simple answer is that tracker
funds pay very low commissions to so called "independent"
financial advisers.
According to the UK Financial
watchdog, our unit trusts are amongst the most expensive in the world.
They have to be in order to pay the high salaries demanded not only by
investment managers but also the professionals who tell us where to
put our money.
So are any of these ‘fat cat’
charges justified?
According to a recent analysis of
unit trusts in the UK All Companies sector, taken from Standard &
Poors’ website http://www.funds-sp.com,
if anyone had chosen a unit trust over the last 12 months they would
have run a staggering 84% risk of choosing a fund that underperformed
the FTSE 100 Index. They had a fair choice, with more than 293 funds
managed by the so-called great and the good.
What is so alarming about these
statistics is that this record was achieved against a background of
poor investment markets. When the FTSE 100 Index fell over 13%,
presumably the highly paid professionals could have sold stock to
avoid the worst of the storm. But they obviously didn’t.
Maybe they performed better when
markets were rising?
Apparently not. Back to Standard
& Poors. Over the 7 and 10 year periods there was a slight
improvement, but only slight, since 82% of investors’ funds failed
to beat the FTSE 100 Index. This means that, 4 times out of 5, we
would have picked a dud fund that performed worse than the Index.
These figures in the table use prices
based on bid to bid, with an adjustment of 5% to take account of an
average initial charge, and with net income reinvested.
What an overwhelming endorsement in
favour of tracker funds. But likewise what an awful indictment of the
quality of actively managed funds. And why do so many of them offer
such bad value for money?
- High charges eat into your
investment returns and dilute any profits you may have made.
- However much you pay an investment
manager he or she cannot be relied upon to outperform the Index
consistently.
So the answer is keep away from
professional advisors and choose a tracker fund yourself. Trackers
will hardly ever appear on the professional’s buy list because, with
no initial charge, there’s often no commission for them. And tracker
funds have a very low annual charge as well, typically 0.5% of the
value of your investment each year.
So the gravy train is perpetuated.
High charging funds, heavy promotion and commission hungry advisors
will continue to push funds which consistently underperform the index.
And when the client complains, they switch you out of one expensive
fund into another, with the promise of a big juicy discount, which is
your own money in the first place.
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