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Graham Bentley: A message to the fund buy-list naysayers

Fund shortlists have been criticised for how constituents are picked, but their value cannot be denied

D2C platforms’ customers have decided they can one-stop-shop for investments – note, not financial planning – on their own, in the same way most of us do not need a personal shopper. Some guidance is sufficient.

Hargreaves Lansdown, for example, is an online supermarket with over 2,500 products available at competitive prices. Its relatively expensive 45-basis-point platform fee on an average account of £83,000 is made less pricey via discounted fund fees, producing a total cost of ownership for a DIY actively managed medium-risk portfolio at around 100bps. Advised clients might expect to pay twice that amount – and cost is important.

The European Securities and Markets Authority’s annual report on the cost and performance of retail investment products proclaims costs represent “a significant drain on fund performance”, which impacts retail investors “to a much higher extent” than their institutional counterparts. It goes on to remind us that, in general, active equity products underperform their passive counterparts in terms of overall returns, despite fees being “significantly higher”.

I would be surprised if HL – or Tesco for that matter – were naïve enough to believe all the products on its shelves were market leaders, so it should come as no surprise that there is no more than a limited number of exceptional funds among the also-rans. It is also logical if those leaders are highlighted as a separate, higher-quality cohort, i.e. a best-buy shortlist.

If there are, say, 100 of similar quality who may qualify but your list is limited to 60, then assuming you are a distributor with a significant impact on fund flows, there will be a price-driven “auction” for membership of the shortlist club.

The winners will not only remain assured of flows but pick up excess business from the losers. Customers benefit via a deeper discount, without a compromise on quality.

A number of commentators have berated HL for its brazen commercialism. Accompanied by a lingering odour of sour grapes, Fundsmith’s Terry Smith has suggested it shortlists funds purely by their propensity to dilute its higher platform fee.

One suspects Lindsell Train’s Nick Train might take a different view, particularly as, in net performance terms, there is little to choose between the two managers, and he has no less an illustrious track record as a retail investment manager.

Train discounted the price of his fund to some 45 per cent less than Fundsmith’s – for a not dissimilar style nor investment potential.

Like most leading retailers, HL has applied what we know about how customers make decisions to its platform strategy. Put simply, the academic literature on consumer behaviour tells us human beings like choice, but not too much.

Shortlists make sense and HL is not alone in that belief. Independent and restricted advisers, let alone other platforms, have buy-lists of what are considered favourite higher-quality funds, to the extent a registered individual wishing to forage off-list may be required to complete an onerous compliance approval process.

Almost 20 years ago, the Journal of Personality and Social Psychology published a paper entitled When Choice is Demotivating: Can One Desire Too Much of a Good Thing? It conducted three experiments to ascertain the impact of choice on decision-making, along with satisfaction levels when the process was completed. In the famous “jam study”, a California grocery store was used to present customers with two different sampling stations, offering “exotic” jams by the UK’s own Wilkin & Sons: one with 24 flavours of jam and the other with only six. Rotation was used to ensure a fair comparison.

The results of the study unsurprisingly revealed that 60 per cent of customers chose to stop at the station with 24 flavours, suggesting “the variety provided in the extensive choice condition was initially more attractive”.

Visitors to both stations sampled similar amounts of jam on average but the revelation was when the purchases were analysed. While only 40 per cent stopped at the reduced-choice station, a full 30 per cent of them purchased, while only 3 per cent of visitors to the more extensive station purchased.

Moreover, the degree of post-sale satisfaction was higher among those choosing from the limited list.

This experiment and similar ones performed since have produced consistent results, reflecting what psychologist Barry Schwartz has termed “the paradox of choice”.

The presence of too many options interferes with our ability to make a decision and, furthermore, to be satisfied customers subsequently. This phenomenon is well understood by online retailers, who have introduced processes such as filtering, default options and social comparison.

Quality need not be sacrificed by using shortlists. Fundscape and gbi2’s 2017 Gatekeeper Report analysed post-listing performance of funds on both D2C and independent researchers’ recommended lists, and found D2C lists from the likes of HL, BestInvest and so on to have no worse (and often better) performance than those from independent researchers.

Platforms, advisers and other distributors using shortlists are simply doing what great retailers do naturally – offering access to a wide range, but helping customers achieve objectives through a straightforward and cost-effective process, potentially with greater value-for-money to boot.

Graham Bentley is managing director of gbi2

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