I have always prided myself in being able to think independently and not simply following the crowd. A good example of this was my rejection of with-profits in 1986. UKPI had just failed and I obtained the Department of Trade & Industry returns for three different life companies and took them along to a friendly actuary for interpretation. When he explained that not all returns followed a standard approach in their calculations, I almost lost the will to live but then opted to avoid with-profits instead. Among those insurers which filed in an alternate style was Equitable Life. Need I say more?
This led to my much used presentation entitled, With-profits – I have never liked it since first I understood it. This presentation focused on the additional risk factor over and above the market in using with-profits – that of the actuarial strategy being applied from time to time. Add to that the general obfuscation over asset allocation and performance and you are effectively recommending a black box – we know it does something but do not know how it is doing it.
As charges undoubtedly remain a focus for regulators, prompted I am sure by the Government that is currently in power, such themed inspections will continue. Iain Muirhead of Sifa makes the valid point that it is performance net of charges that matters and not the level of the charges. That in a way is what we can hope from the FSA’s research into multi-manager but I doubt it will support the multi-manager approach in all circumstances.
Risk is something that we need to explain to clients and layering techniques of any type make that even harder. Some say that multi-manager has succeeded as advisers sub-contract investment decisions to the multi-managers. Where professional advisers take this hand-off approach, how do they still justify taking full commission or am I being unfair? Just what is the optimum number of funds? This is another point the FSA might wish to consider or, better still, what drives the number of funds selected?
More important is that fund of funds simply magnifies the passive versus active argument. I recently came across some US-based research where the major funds were being checked as to the level of closet tracking that was going on. In one major fund, some 97 per cent was to all intents and purposes a tracker fund and only in the other 3 per cent was any discretion being employed.
The calculation of an active expense ratio can be demonstrated where you allocate a tracker-level charge in proportion to the actual amount closet-tracking, then allocate the balance of the annual charge to the balance that is not tracking. In this case, this element was effectively paying over 5 per cent in AMC terms.
It is essential that we recognise that as long as we know what we selling and understand it, that is fine. Where we head for the abyss is where we do not understand it all or even in part.
As Ray Davies of the Kinks sang: “They seek him here, they seek him there.” He was singing about the dedicated follower of fashion. If the regulator is seeking the equivalent in our sector, let us ensure we make our investment decisions consciously and not just as part of the crowd.