THINKING of dabbling in a bit of fund investing but don’t know where to start? Who could blame you - with a recent study from watchdog the Financial Conduct Authority (FCA) noting that there are 1,840 asset management firms registered in the UK, each offering numerous different funds and styles of investing, the choice is staggering. And, if you don’t know your alpha from your beta, frankly confusing.
Anyone thinking of buying into an investment fund should first consider their attitude to risk as well as how much they are willing to pay a fund manager to run their money for them. In general terms the more risk you are willing to take on the more chance you have of making a higher return, but equally the higher the chance of you losing money.
In truth the chances of losing everything are extremely slim, especially when invested in a fund, which diversifies risk by investing in a range of different assets. Plus, the best managers will know how to spot a company that is on the turn and adjust their portfolio accordingly.
Which is where the active versus passive debate comes in.
In its recent interim report on the asset management industry, the FCA noted that passive funds track an index such as the FTSE All-Share by holding securities “in proportion to the market”.
“Passive funds offer investors similar levels of risk and return as the market,” the report said. “Actively managed funds often offer investors the chance to ‘beat the market’, albeit with a corresponding risk of underperformance.”
The problem is that once their charges have been factored in many active managers do not actually outperform by much and their charging structures can be so opaque that the FCA has recommended they all adopt an all-in fee.
“Our evidence suggests that actively managed investments do not outperform their benchmarks after costs and that some active funds offer similar exposure to passive funds, but charge significantly more,” the regulator said.
But does that mean investors should shun active funds and invest only in passive ones? Duncan Gourlay, associate director at Weatherbys Private Bank, thinks so.
“We are convinced tracker portfolios will deliver better risk-return outcomes than chasing the latest fashionable manager,” he said.
"Unfortunately, too much of the asset management industry is set up to look after the manager's interest, not the investor's.
“The evidence strongly suggests there's no persistence to any temporary outperformance active managers deliver. This means picking managers based on their sales pitch of outperforming is very dangerous for your wealth. If they've outperformed for three years, what happened in the fourth that they don't want to include it in their numbers?”
For Justin Modray, director of Candid Financial Advice, while tracker funds are great in that they offer low-cost access to many different markets, “it’s important to remember that a tracker is only as good as the index it tracks”.
“Since many indices, such as the FTSE All-Share, are weighted you’ll often find your money is skewed towards a handful of larger companies rather than being spread equally across all the companies in the index,” he said.
“It means that FTSE All-Share trackers have a bias towards the financials and energy sectors, which will impact performance for better or worse. This is fine provided you bear it in mind.”
Jason Hollands, managing director of financial services firm Tilney Bestinvest, noted that even though fees on passive funds have “reduced dramatically in recent years as tracker providers have been engaged in a price war” they still mean that trackers will underperform to a small extent.
“A traditional tracker is guaranteed to underperform slightly, because it will have running costs – albeit small – that the index it seeks to replicate will not have,” he said.
“While a large slug of active fund managers have not outperformed over the long term, especially in certain highly efficient markets such as the US, there are also managers who have significantly outperformed over very long periods,” he added, noting that active fund management tends to have a better track record in markets such as those in the UK and Europe.
The key, said Hollands, is to identify managers “with genuine skills, worth paying the fees for”.
The trouble is that while past performance will give you an indication of that, all fund houses are at pains to note that that alone cannot be a guide to future performance. And besides, if you could work out how much of a fund’s rise was down to the manager’s stock selection and how much was down to the market rising anyway, you could probably just go ahead and launch your own fund.
It is clear, then, that choosing where to invest your cash is no easy pastime, but bear in mind that investing in funds is in some senses as much of a gamble as investing in the individual stocks themselves.
Just as you would be a fool to pile all your savings into one company’s shares so too it would not be wise to entrust one fund manager or one investment style with your entire investment pot.
As Modray said: “In practice it makes sense to combine both passive and actively managed funds. Passive funds can form a good core to your portfolio, providing mainstream access to markets and using good actively managed funds that invest very differently to the index can help spread risk.”
Or, as Hollands put it: “The reality is that no single approach to investing is a panacea that will work well all of the time. The right approach is an agnostic one where investors have every tool available in their kit box and are prepared to utilise different approaches within a portfolio.”
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