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Investment trade body inadvertently reveals fund manager underperformance


Data included in an Investment Association report to highlight the absence of hidden fees in the asset management market shows the poor returns delivered in some sectors, prompting industry experts to call for underperforming fund managers to cut their charges.

This week the Investment Association said it found “zero evidence” that funds’ returns are affected by hidden fees in an analysis of 1,350 active and passive managers.

But the same data showed that across 16 sectors and three 12-month periods, in 23 cases managers underperformed the benchmark net of fees. In 25 cases they outperformed the benchmark net of fees, but sometimes only marginally.

Examples of the worst underperformance include the average performance of funds in the Japanese Smaller Companies sector in 2012-13, which was 11.03 per cent less than the benchmark, net of fees, and the average performance of the European Smaller Companies sector, which was 7.94 per cent less than the benchmark after fees.

In the 2014-15 period just six sectors outperformed the benchmark on average after fees. The average of all funds underperformed the benchmark by 0.37 per cent after fees.

The biggest underperformance in 2014-15 came from the North America and North American smaller companies sectors, which underperformed the benchmark by 3.51 per cent and 4 per cent respectively.

The Investment Association research found the average ongoing charges figure for funds was 1.42 per cent, with transaction costs across equity sectors of 0.17 per cent.

Former Investment Association chief executive Daniel Godfrey says that if funds can guarantee they will beat the index each year for a fee, then the cost is worthwhile.

He says: “But we know funds will not beat the index consistently, and we don’t know which will and won’t do well, so it’s probably not worth the extra payments.”

Gbi2 managing director Graham Bentley says the issue is not around whether active managers work or do not. 

He says: “It’s clear that active management can work but there are some people that are much better than others. The question is then why are they all charging the same amount? Surely the funds with better performance would be more highly valued than those that aren’t, and the poorer performers would cut their fees. But they don’t as they know they can get away with it.”

Bentley adds that good managers recognise that there will be periods where their style does not work, such as recovery managers who hunt for deep value that can take long periods to be realised.

“The issue is when they tell you they will produce consistent returns in all markets, like Standard Life GARS, which hasn’t performed over the past 12 months. You should have a mea culpa moment, and say you have not delivered what you said you would deliver and as a result will reduce the AMC this year by 20 basis points. But of course they won’t,” he adds.

“From lots of fund managers’ point of view cutting of AMC is a recognition of failure.”

Godfrey says the average performance figures highlight that investors need to either opt for passive strategies or high conviction funds.

“I think you have to make a choice between index funds, which are cheap and you know what you are getting, or high conviction active funds run on a much longer term basis that don’t care about the index and give better returns than the index but not every year.”

Bentley agrees, adding that high active share and R-squared figures – which measure how a portfolio differs from the benchmark – is a good way to weed out closet trackers. However, he points out that only a handful of investment managers publish this information.

Hargreaves Lansdown senior analyst Laith Khalaf says performance is of equal importance as charges.

He says: “Investors must also take performance into account when choosing a fund, in reality the dispersion of returns is much more heavily influenced by manager skill than charges. Over the last 10 years the best performing UK stock market fund has returned 12.7 per cent a year, the worst has returned just 1.2 per cent.”

The Investment Association says that for the UK All Companies sector, the largest sector by assets, the average fund has consistently beaten the benchmark after fees, with 1.27 per cent of outperformance by active managers after fees.

It also notes that there are small sample sizes in some of the other, smaller sectors, although the data used gathered the largest UK-domiciled funds by assets in each sector, accounting for between 50 and 65 per cent of all assets under management.

However, there is more work to do to make costs more transparent, argues Godfrey, including coming up with an industry standard for portfolio turnover rates.

Asset managers currently use different measures to calculate the rate. The Investment Association has previously issued a discussion paper on the topic, but says work is ongoing.

Godfrey says: “There is no standard definition in the industry on how to source that rate. I don’t care about the definition, just that there is a standard and it is clear on the volume of transactions.”

Bentley says high portfolio turnover rates need to be justified.

“The guys that are trading more have a cost drag on performance. The propensity that people have to trade just keep increasing.”

He asks: “If you have just launched a brand new fund and people are giving you a lot of money then you will get a very high portfolio turnover rate, just because you’re buying new stock all the time. But if you have a relatively mature fund and have high portfolio turnover then you’re a trader, but are you more a speculator than an investor?”



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