Active fund investors can live in hope

MoneywiseEditorMark's picture
In the past few months a furious row has developed among investment professionals, with financial journalists like yours truly caught squarely in the middle. On one side stands the active fund management industry, on the other side are proponents of ‘passive’ investing.
The argument was kick-started by a public relations executive (and ex-financial journalist) who wrote a blog claiming that financial journalists “have absolutely no idea what they are talking about”.
A director at Sensible Investing (SI) – a not-for-profit campaign group financed by a wealth management firm – chose that blog as a springboard to complain about a media bias towards active funds. The row inevitably sucked in personal finance journalists as well as others in the industry, such as Richard Romer-Lee, the prominent founder of ratings agency Square Mile.
He accused the fund industry’s trade body – the Investment Association – of failing to defend the interests of active fund managers amid all the negative rhetoric.
So far, so boring for everyday investors, who are simply not interested in self-serving individuals or industry insiders claiming their way of investing is the only way.
It’s true that investors and journalists can be seduced by the idea of the star fund manager with the Midas touch, the investment guru who can take their £1,000 lump sum and turn it into £10,000 in just a few glorious years – and there are managers who outperform impressively from time to time, creating wealth for investors. However, it’s also true that many active funds fail to perform, many lose money, and charges are far too high.
But the binary argument of active versus passive fails to take into account investor psychology. In the same way that many people invest in premium bonds despite the odds being against them (most bond holders stand next to no chance of scooping a £1 million prize and are likely to end up with a lower return than that offered by the average cash savings account), private investors want to at least have the chance of achieving an above-average investment return.
Passive funds do not excite them because they know they can never outperform an index. They would rather pay more (sometimes a lot more) for the chance to do better, even if that chance is slender in the extreme. Most investors are unlikely to mute their sense of blind hope or optimism, no matter how many angry blogs are written about active funds. Calling for 80% of the active fund world to be cut overnight, as SI has done, is not a helpful suggestion (and it would be impossible to restructure the entire fund management industry anyway).
Nor is it sensible, as our PR man above proposed, to do away with journalists completely and allow financial services firms  to create content. Would the public really benefit from the abolition of journalists in favour of corporates spinning their own yarns?
A better idea is to improve transparency – of charges and fund information – so that investors can see exactly what active fund managers are investing in and exactly how much they are charging for it. 
At Moneywise, we welcomed recent research by the Financial Services Consumer Panel (FSCP), which found that people investing in funds directly or through their pensions and stocks and shares Isas have little idea of the true costs of doing so.
The FSCP recommended that investment managers be required to quote a single and comprehensive annual charge, including estimates of forward costs such as transaction charges. I think this is a sound idea.
At Moneywise, we’ll do all we can to press for reforms of the way fund groups levy charges, what those charges are, and whether they are justified. Once investors have all that information, they may well decide to go down the passive investing route. But if I’m honest, I still think many will choose active managers regardless. Hope springs eternal, after all.

Your Comments

Well done for discussing this issue when so many in the financial media are burying their heads in the sand and hoping it will go away!
Two points. First, you're right to say the chance of an ordinary investor picking a fund manager that will consistently outperform "is slender in the extreme". Research has consistently shown that only about 1% of managers do so, they're almost impossible to identify in advance, and even they recoup for themselves any value they add in charges. But you'd never guess that from reading Moneywise or almost every newspaper money section and investing magazine on the market! The financial media is obsessed with forecasting, chasing performance, picking stocks and funds, and whether it's time to buy and sell. If journalists wrote about what investors should be doing - investing in a highly diversified, low-cost portfolio and then more or less forgetting about it - they'd soon run out of things to say. And of course their jobs are effectively funded by advertising revenue from the fund industry. There is a symbiotic relationship between the media and the industry which suits them both but does a huge disservice to the consumer.
Second, we at Sensible Investing are not suggesting that the fund industry could (or should) be cut down to 20% its current size overnight. But all the evidence is that an industry of that size would still be sufficient to keep markets efficient. Less competition would also give genuinely skilful managers (very, very small in number though they are) a much beter chance of beating the market than they have at present.
What we need, as you say, are clear, transparent charges that spell out the NET returns (because it's returns AFTER COSTS that really matter) - and, crucially, the ability to compare them, like for like, with net returns from "passive" or "semi-passive" funds. When that happens, hundreds of actively managed funds will quickly go out of business. The media has a vital rôle to play in bringing that about. So please, Moneywise, we want fewer gushing articles about "star" managers and more serious journalism that brings the UK investing industry, and the hugely powerful lobby behind it, to account. Otherwise I'm afraid you're part of the problem, not part of the solution.
Robin Powell, Sensible Investing TV