Value for money in fund management is about much more than just returns
How much money would you be prepared to pay to enter a casino? Since the house wants you to play, you might expect access to be free. Unless, of course, there is value to be had from the visit besides the siren call of the roulette pill clattering into a pocket, and a dream of wealthy outcomes.
It may surprise you to learn that Singapore’s two vast modern casinos charge locals an entry fee of S$100 (around £54). There is no ‘added value’ here — the fee is a government levy designed to deter locals from gambling.
Foreigners, with a perceived attitude to hard work and discipline inferior to the native Singaporeans’, are free to lose their Ralph Lauren shirts at one of each resort’s 500-plus gaming tables without restraint.
Casino de Monte-Carlo, meanwhile, also charges for entry, but this comes in recognition of the fact that the building’s legendary status, Beaux Arts architecture and covert ambience possess more than a certain cachet, attracting hundreds of non-gambling tourists.
This is value-for-money gambling — providing rarity value, a cinematic icon and a sense of opulence. Otherwise, the games are just the same, with exactly the same odds of winning.
Crossing the spitting distance between gambling and investment, value for money is, of course, central to the FCA’s current inquisitorial approach to its relationship with fund management, and latterly to platforms.
A number of respected industry commentators seem to struggle to find relevance between value for money and fund management.
The venerable publishing personality Lawrence Gosling recently suggested that the FCA was dressing up ‘cheap’ as value for money, and that the test is simple: what is the return?
He felt that most investors would agree that a fund with lower costs, and better performance, is one that has provided better value.
At the other extreme, investment muggles are shocked to discover what should be self-evident — that securities transactions are not free, and therefore are a significant contributor to total costs. Their arithmetic similarly takes no account of returns, which are net of those fees in any event.
As Gosling inquired, “does that mean (funds with low transaction costs) are better value for money than funds that trade more?”
He also referenced Hawksmoor Investments chief investment officer for private clients and head of research Jim Wood-Smith’s comparison of fund value for money with that in house building. Buyers have surveys carried out to ensure that the house will not collapse, and to confirm what it is worth. But there is no requirement for the house builder to demonstrate the price represents value for money.
I would argue that analogy is overstretched.
The professional design, sourcing of materials and construction of a house requires skill. House building is not determined by luck. Throwing 10,000 bricks, pipes and wiring into the air in Surrey and expecting them to land neatly in the form of a four-bedroom mock-Tudor detached family residence is somewhat optimistic.
Investment, on the other hand, is at least part luck. As behavioural finance guru Daniel Kahneman proclaimed, success equals some talent and luck. Great success, on the other hand, equals some talent and a lot of luck. Over time, luck reshuffles the fund manager pack and places most of the cards in different places on the returns distribution curve.
Extreme good or bad luck eventually reverts to the mean. Skill does not, and that is a differentiator, along with price.
Consequently, value for money feedback based on returns is useless unless it distinguishes between skill and luck. The price I pay is 6 basis points for admin and custody; the premium should be for skill, or service benefits.
Some commentators claim investment return is all the product of luck. There is an easy test for this, incidentally. See if you can consistently lose money through long-only stock selection on purpose, excluding fees. If you can, some skill must be involved.
The problem is that we need a very large data sample to determine skill content versus luck. This implies using managers with long track records, and in respect of the same fund.
It can be argued that fund managers with less experience, or shorter track records, exhibit insufficient evidence of skill to warrant a significant premium over the 6bps admin cost associated with a passive fund.
In any other industry I might expect to pay less for inexperience or limited tenure. Businesses in that industry would have a value proposition and an associated marketing strategy.
Since value propositions either involve lower prices (the same product costs less), more benefits (a better product or experience for the same price), or a combination (higher quality costs more), fund managers need to identify what proposition suits their target market, over and above their ability to exhibit skill.
Strategies can include: making a product easier to buy, providing earlier and more regular gratification, incorporating a ‘must have’ innovative feature, lowering the cost of ownership by reducing the need to spend time and money post-purchase, and so on.
It is not beyond the wit of marketeers and product designers to apply these ideas and more to the financial products and services that they offer clients.
In fund management, value for money is not just about returns. It is about the cost of skill, and the casino-like entry fee that is no more than the price paid for luck. It is also about all the other product attributes — tangible or otherwise — that influence customers’ buying decisions.
Fund groups’ product development and marketing departments need to form strategies around these issues, rather than simply regurgitate platitudes about unique investment propositions and boffin investment managers.
Or they could always just place their trust in luck.
Graham Bentley is managing director of gbi2