TOP 5 REASONS WHY FUND MANAGERS WASTE YOUR MONEY

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monkey - edi zoo(First published in Ingenious Britain)

 

50 years ago people managed their own investments. Somehow that gradually changed and fund managers now totally dominate equity markets.  But how good a job are the fund managers you employ doing, and what are the alternatives?  Here are 5 reasons why you should consider managing at least some of your investments yourself.

 

1.    The investment profession is built on an illusion of skill

Although fund managers are usually very knowledgeable and sound convincing, the bulk of research shows that they are unable to outperform the “market”.   Even if there were a few fund managers out there capable of such a feat, it is an impossible task for individuals to find them.  “Independent” financial advisors often attempt this task, but again research finds their track record is extremely poor, as they tend to favour managers with recent strong performance, which tend to be the managers that do worse in subsequent years.

 

According to a Which? report, only 38% of active fund managers have beaten the FTSE All Share index over ten years. This demonstrates there is no skill as you’d expect that number to be 50% (half do better half do worse – but it’s the fees that make it even worse than 50:50).

 

“… Professional investors, including fund managers, fail a basic test of skill: persistent achievement. ”

– extract from the utterly brilliant ‘Thinking Fast and Slow’ by Daniel Kahneman.

 

2.    Fund managers are really expensive

When (and indeed if) investors look at a typical fee paid to a fund manager, the 1.5 to 2% a year may not sound a lot.  But it’s worth noting the FTSE has a dividend yield of 3.7% at the moment – paying out 2% in fees each year is more than half your expected income. Over 30 years the impact is to more than half the value of your investment.

 

These are just the costs you can see – there are also hidden layers of charges for intermediaries, plus fund manager often turn over 100% or more of the portfolio each year, creating significant costs.

 

3.    Even monkeys can outperform fund managers

Almost without exception, fund managers have a benchmark – an index which they attempt to outperform.  Unfortunately, the benchmark is a poor investment strategy. The bulk of money is still managed against market cap weighted indices, which put more money into the most expensive stocks.  Recent research from Cass Business School found that you would be better off getting monkeys to choose the stocks in your benchmark!

 

4.    Inferior tax breaks

Tax breaks that are available for investors in listed stocks are lightweight compared to the amazing tax breaks available from investing in businesses that are eligible for EIS or SEIS relief.  In certain scenarios you can claim up to 100% of your investment back – meaning you’ve risked  nothing.

 

5.    Equity investing is not helping the economy or companies

Apart from the odd (increasingly rare) IPO, money doesn’t reach the company you are buying shares in. Whilst fund managers buy and sell shares, the money changes hands, but it doesn’t go into the company’s bank account and help the business grow in any way. Compare that to an investment in a growing business. If the company is a success, everyone – business and investor – benefits from the increased value.

 

John Kay undertaking his review of UK equity markets has talked at length about the fact that modern equity markets are broken. They are no longer about allowing companies to raise capital. Paper being passed around the market in this way is a zero sum gain and doesn’t benefit the economy – other than by providing income to financial intermediaries.

 

If fund managers have all these disadvantages what is the alternative?

Index trackers certainly improve performance by lowering costs.  Investors can also invest directly in shares.  Both of which are really sensible alternatives and a whole load of websites exist to help you do that; Best Invest Select, Hargreaves Lansdown , Interactive Investor and some newer players like Nutmeg.

 

However one new option that savvy investors are increasingly turning to as part of a diversified portfolio is the nascent crowdfunding market, which enables individuals to buy shares in unlisted companies. When we compare crowdfunding to the list of issues related to traditional fund management, it scores surprisingly highly.  Crowdfunding avoids fund management fees completely.  Although smaller companies are more risky, they also offer higher potential returns. Crowdfunding allows diversification as the investment sizes can start from as little as £10. Many of the companies seeking funding are also EIS or SEIS eligible, providing huge potential tax breaks.

 

Investors may worry about not being able to sell shares easily (if at all) but they should be aware how destructive each and every transaction can actually be to the value of their investment. Liquidity isn’t always a good thing. Sometimes, being locked into an investment for a period of time is exactly what’s needed to preserve the actual value of an investment.

 

My final and most important point – investing yourself is much more exciting and rewarding: you are directly helping companies that need funding to grow. After all, you get to play Dragon’s Den or be your own Lord Sugar and invest in who or want you really believe in.

 

Jude Cook

 

@ShareIn

Photo:http://www.flickr.com/photos/wwarby/

jude@sharein.com'

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