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Paul Farrow: Most funds are duds

Like many holidaymakers, I thought I had a bargain recently when I booked a cheap flight to Portugal. It was under £40. But, like many before me have discovered, the £40 fare was just the start of it.

A host of extras quickly doubled the fare. There was the check-in fee, a handling charge, a fee for the confirmation of the booking to be sent by text and finally a charge for putting luggage in the hold.

I expect many investors are similarly deflated when they learn that the annual management charge they pay for a fund such as a unit trust is just the start of it.

There has been growing support for the anti-fee brigade led by Alan Miller and Terry Smith – much to the annoyance of the fund management industry which, perhaps, believes they are being somewhat hypocritical, given their past.

The Investment Management Association has been vociferous in the industry’s defence – there has even been a “blogging war of words”. But it is clear that its arguments have yet to satisfy everyone.

Of course, investors cannot expect to buy a fund for free. Companies need to levy charges to cover their costs. Even something as simple as sending out a valuation statement costs money.

And, to be fair to fund groups, initial charges have also come down considerably. The fund factsheet might stipulate the initial fee is 5 per cent, but most investors no longer pay this amount. Financial advisers often rebate a sizeable chunk back to their clients while fund platforms offer funds with no upfront fee at all.

Outgoing IMA chief executive Richard Saunders reckons that his organisation’s study has proved that TERs are a decent measure of costs and that, when a fund under-performs, it has little to do with cost, it is more to do with poor investment decisions.

The IMA study is certainly selective and far from conclusive. Not including performance fees because they are few and far between doesn’t stack up. It is a point made by Miller who notes that performance fees are becoming more common, not least in the popular absolute return space.

That said, Saunders might have a point on investment decisions, although this does not get him or his member organisations off the hook – far from it.

The crux of the matter is not so much the cost; it’s the level of return investors get for paying more than they bargained for.

In short, investors won’t have any reason to question charges if their fund is outperforming and delivering decent returns.

The facts remain that tens of thousands of investors pay too much for substandard performance and are simply not getting value for money.

There are fund managers that justify their charges but, given there are more than 2,000 funds available, there are hundreds that are dead wood.

There would not have been too many Chelsea fans begrudging Fernando Torres the tens of thousands of pounds a week he gets after he scored against Barcelona to send Chelsea into the Champions League Final but there were plenty up in arms during his goal drought earlier the year.

Likewise, I am not rushing back to book with a certain budget airline because I am not convinced I got value for money. Transparent and fair pricing is important but it is the actual returns in pounds and pence that count. I fear that all the focus on cost is overshadowing the real problem – that most funds are duds.

Paul Farrow is personal finance editor at the Telegraph Media Group


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There is one comment at the moment, we would love to hear your opinion too.

  1. In common with a number of other topical debates, we are unlikely to see a synthesis of opinion anytime soon.

    The active fund camp say it’s all about value, and the passive camp say it’s all about price. Clearly, these warring factions are never going to agree.

    What is undeniable is that objective analysis can provide investors with valuable guidance in this respect.

    Yes, I agree that it makes no sense to pack a portfolio with only active funds, when it is beyond argument that most of them will fail to generate alpha. Equally so, pure passive stocks can act as effective proxies for asset allocation, but provide little potential for alpha.

    One of the successes of RDR has been to encourage passive strategies; although I personal believe that mixed strategy of using passives for asset allocation beta, with active funds for tactical alpha plays is the way forward.

    Certainly price isn’t everything, but given the option between lower costs and the vague possibility of alpha, and I know which one my clients will opt for.

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