Time to give up on investment funds? Not all of them

A new report from the Financial Conduct Authority makes grim reading if you have money invested in the stock market with a fund manager: the City regulator says the £7trn UK asset management industry charges too much, performs too poorly, and relies on a lack of transparency to ensure investors let it continue to get away with fat profit margins. It’s enough to make you wonder whether you should give up on investment funds altogether.

If that’s how you’re feeling, however, take a moment to reflect. The reality is that most investors prefer to get their stock market exposure through a fund because it offers professional management and pools their money with that of other investors to ensure diversification. It’s also worth pointing out that the regulator is now promising reforms.

Note too that investment companies were not covered by the FCA in their investigation. This is perhaps because these funds are stock market companies in their own right – rather than products designed, developed and delivered by a fund manager. That status is important since all companies must be run according to strict laws protecting shareholders’ interests – investment companies’ boards have a legal duty to hold fund managers to account on behalf of investors.

Nevertheless, the FCA’s damning verdict on asset managers should give investors pause for thought – are you really getting good value for money, however you’re choosing to invest?

The pseudo trackers

One accusation in particular sits at the heart of the FCA’s inquiry: that with too many funds, asset managers are charging for a service they’re not providing. If you’re invested in an actively-managed fund, you’re paying higher fees to a team of professionals who pick and choose individual investments with the aim of producing a better return than the market as a whole; if they don’t pull off that trick, you’d have been better off with a low-cost index tracking fund that automatically mirrors the performance of the market.

The FCA says that not only are active managers not very good at beating the market, many of them aren’t really trying; the choices made by such managers mean their funds look so like index trackers that it’s difficult to understand what investors are paying for.

The effect of higher charges is often underestimated. A typical active fund might charge 1.5 per cent a year, which sounds small, even when you hear that the cheapest trackers start at 0.1 per cent a year. But investing £10,000 in each of two funds and then earning an average annual return of 7 per cent for 10 years: in a fund charging 1.5 per cent a year, your money would be worth £16,929, while in a fund with a 0.1 per cent charge, you’d end up with £19,475. That’s quite a difference.

Holding asset managers to account

How, then, can you be sure you’re not being ripped off in an actively-managed fund? Really, there are just two issues to get to grips with.

First, you need to be happy to sign up for higher charges in the first place. If you’re going to pay a fund that charges, perhaps, 15 times’ more each year than a cheap tracker, you need to have spent enough time thinking about whether it’s the right investment for you. The higher the fee – and some more specialist funds have even higher costs – the more you need to weigh up whether it is right to pay it.

The second consideration is performance. Over time, you need to carefully monitor whether you’re getting what you’re paying for. If you’re paying high active fund charges but consistently seeing returns that are bettered by index trackers, don’t be afraid to take your money elsewhere.

Finally, to return to investment companies, these two issues should define the questions that independent directors are asking on your behalf. Unless the directors of your fund are working to satisfy themselves that the asset manager is delivering good value, they’re not meeting their responsibilities to you. They too have the option of taking the money elsewhere, by appointing a new asset manager if the incumbent disappoints.

This isn’t to suggest investment companies are a panacea for the asset management industry’s problems – some of these funds have disappointed too. But at the very least, they offer a governance structure that puts accountability on a formal and legally binding footing. That may prove a very valuable protection for investors.