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Charge of the light brigade

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David Ferguson
A few weeks back, I enjoyed a splendid lunch with the individual who was the first CEO of an asset management group to pay trail commission to IFAs.

When the wide-ranging conversation turned to the recent entry of Vanguard to the UK, we found ourselves furiously agreeing that this represented the greatest shift in mutual fund pricing in 27 years.

There is some variance emerging around the previous cartel-like pricing but it is not difficult to see why a spread of about 60 basis points between active and passive management for UK equities might result in a few questions being asked.

Dimensional has blazed a passive trail in the UK but I cannot help imagining that Vanguard's greater might will drive more rapid growth.

I should say before going any further that these words are in no way intended to debate the merits of active versus passive management. Rather, they have been penned in an attempt to stimulate discussion about the accountability of asset management, whether active or passive.

It has confused me for nearly 20 years why people are willing to pay a full active management price for funds that are effectively 80 per cent index tracker.

Why not invest 80 per cent of the portfolio in a low-cost passive fund with the balance being looked after by a highly skilled (and commensurately priced) manager?

The weighted cost will be far more reasonable and each element can be measured for fairness of cost and accountability around delivery of performance.

For far too long, the client has been paying a very fat price for mediocrity but the game is up.

It may be helpful to try to understand why Vanguard has chosen 2009 to introduce its proposition to the UK.

To my mind, it can be for no more complex reason than that for as long as UK IFAs relied on commission as a means of remuneration, there was no incentive to recommend unloaded passive funds, as most are.

Similarly, as fund supermarkets are generally unable to offer a full range of passive funds (due to an absence of kickbacks), it is only as wraps and fee-based advisers begin to dominate net inflows that passive management can start to build meaningful market share.

Of course, the emergence of scale in passive management will not result in the collapse of the active management market. What it will do is focus more attention on what is being delivered by active managers in relation to the premium being charged.

Ultimately, this can only result in lower overall costs for customers which - when coupled with greater emphasis on performance - can only be a good thing.

With a fair wind, we will see some consolidation in what is a hugely oversupplied sector alongside more growth in the high-alpha boutique side of the market.

All these factors are combining to ensure that only those most resistant and blind to change could sensibly argue that the days of outrageously high margins for managing lazy money are sustainable.

Future analysis will be smarter and, rather than focus on price, performance or even brand, more enlightened advisers will view price and the prospects for risk-adjusted returns as the key indicators.

David Ferguson is chief executive of Nucleus

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