Interactive Investor

Fund failings: Three quick fixes for the fund management industry

Kyle Caldwell outlines three changes he would like to see implemented by the industry.

20th August 2019 12:16

Kyle Caldwell from interactive investor

Kyle Caldwell outlines three changes he would like to see implemented by the industry to enable it to better serve investors.

The Neil Woodford fallout risks damaging the reputation of the fund management industry. Various studies and, indeed, official ISA statistics show that most people in the UK prefer to stick to the relative safety of cash rather than put their money to work in the stock market. For some, investing is viewed as too much of gamble; others cite a lack of knowledge as the reason they don't invest.

Woodford's woes will not help matters, prompting some to conclude that if the UK's most famous investor can lose his touch, so can any other fund manager – so why bother investing at all?

One big winner from all this will be the banks, as savers will be more resistant to taking the step up to investing. Passive funds will also benefit, as more investors opt for cheap trackers that operate without the input of stockpicking skill or managerial ego. Passive investors point to the fact that when it comes to actively managed funds, outperformance is far from guaranteed. In reality, most funds fail to consistently beat the stock market against which their performance is pitted.

There are skilled fund managers out there, but they are not easy to find. And it is worth bearing in mind that because of the way they invest, even the best of them are highly unlikely to outperform year in, year out. As Money Observer regularly points out, neither fund performance nor stock markets move in a straight line; instead, they go through good and bad periods. However, over a long period of, say, five to seven years, a skilfully managed fund should outperform a passive fund, which merely tracks the performance of a particular stock market index.

Fund management companies regularly stress the importance of investing for the long term. But they really don't help themselves on a number of fronts, and as a collective entity they fail to engage with end customers. Here are three areas where significant improvements could be made to increase consumers' interest in actively managed funds and gain their trust.

1) Pass on economies of scale

When it comes to fund management charges, most firms toe the line and quote an ongoing charges figure (which does not include transaction costs) of around 0.8-1%. Some charge slightly less, others a bit more, but in general there is a serious lack of competition on the charges front.

One aspect of this practice is that economies of scale are generally not passed on. With open-ended funds, the same fee is generally levied even if the fund grows from £100 million to £10 billion (although the same cannot be said about investment trusts). Such cost savings should be passed back to investors in the form of lower charges.

Fund manager M&G announced in mid-June that it will be introducing "discounts" on fees for investors in its larger funds – those with assets of more than £1 billion – thus passing on potential savings from economies of scale. The move is a welcome one, but the fee reductions start off very small, at 0.02%, rising to 0.12% for funds with assets of more than £6 billion. In pounds and pence terms, this really shows: an investor with £10,000 invested would save between £2 (not even the cost of a cup of coffee) and £12.

Lee Goggin, co-founder of findawealthmanager.com, agrees that economies of scale should be passed on to investors in the form of lower fund charges. He says:

"Putting in place a tiered fee structure should be the norm, so that when funds T grow to a certain size, the fund charge reduces."

Remedy: Reduce charges as funds grow in size, especially in the case of behemoth fund management companies with many billions of pounds under management. For boutique fund managers, who have more overheads, achieving economies of scale is more difficult, but when costs savings have been made, they should pass them back to investors in the form of lower charges.

2) Ditch the jargon

As well as being more open with investors by spelling out what they pay in charges and the details of their portfolio holdings, fund managers need to communicate better. At the moment, some firms provide investors with fund factsheets that contain information a couple of months out of date. Information needs to be made available for investors to digest much more quickly, so that they can make better-informed decisions. In mid-June a factsheet dated the end of April has limited value.

This leads to my next big bugbear: the widespread use of financial jargon. Financial literature is littered with lingo and acronyms that only industry insiders understand. Terms such as 'bottom-up', 'top-down' and 'clean share class' are baffling to those not in the know. Jargon is a barrier that deters people from investing.

According to one analyst, the fund industry hides behind the obligation to meet rigorous compliance standards when it uses terminology in marketing literature, and this is often at the expense of clarity for consumers struggling to understand the jargon.

"We are challenging our own compliance officers to use as few words as possible and to keep it simple, so that the information for the end investor is accessible and relevant."

Dan Brocklebank, head of Orbis Investments in the UK, points out that fund investors are often served up thoughts on the global economy, rather than information on where their money is being invested. He says:

"Explain in simple terms why you own certain companies, rather than trying to forecast the future. Also admit it when you make a mistake and explain what you have learnt."

Brocklebank adds that highly complicated and opaque investment approaches don't necessarily result in better returns. But rather than shying away from the perceived complexity altogether, he says, it is best to look for a manager with a straightforward approach that you can understand.

Remedy: Communicate in a clear and concise manner. Tell investors in jargon-free language how their money is being invested and give them a simple explanation for changes to the portfolio on a monthly basis. Don't use words or terminology that a beginner investor would be unable to understand.

3) Be more open with investors

Various regulatory reforms over the years have forced fund managers to become more open with investors. One recent rule requires fund managers to formally disclose transaction charges incurred by their fund when stocks are bought or sold. This charge sits outside the ongoing charges figure (OCF). A study last year by The Lang Cat, a consultancy, found that, overall, transaction fees add around a third to the OCF, so the total fee skimmed off by a fund management firm is more like 1.1-1.3%.

However, despite the requirement to publish this information, the transaction charge is not shown in the main piece of literature an investor is likely to look at before buying a fund: the fund's factsheet. Instead, investors have to dig through the key information document or read a cost disclosure breakdown provided by their broker.

There's also a lack of openness in terms of portfolio holdings. At present the vast majority of fund firms only name their top 10 holdings on a monthly basis, typically on the fund factsheet, with the party line being that the full list of holdings is commercially sensitive. On the one hand, this has merit; indeed, why would a fund manager want to reveal their investment selection to the whole market? On the other hand, just as when an investor buys a tin of beans with details of the ingredients, they should be able to access a full list of the holdings in any fund they are considering buying.

Neil Woodford is an exception to the rule, as holdings were (up until the fund suspension in early June) published in full every month. A small number of firms publish quarterly. The official stance from the Investment Association is that funds must disclose their full portfolio at least twice a year. However, this instruction is considered best practice, not a rule, so fund management groups don't have to follow it.

Remedy: Spell out transaction costs on fund factsheets. If an investor asks to see a list of all holdings, make that information available to them. After all, fund managers are working on behalf of their investors. As with buying a tin of beans, if a purchaser wants to see a list of ingredients, they should be given one.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

This article was originally published in our sister magazine Money Observer, which ceased publication in August 2020.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.