There are two investment management styles: active fund management and passive fund management.
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Active fund managers aim specifically to manage a fund by achieving growth in excess of a benchmark index. They do this by stock picking or speculating on market movements and by actively trading securities within a fund.
The buying and selling of underlying securities is known as portfolio turnover. Active fund managers have high turnovers in order to try and generate excess returns.
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“The laws of arithmetic have been suspended for the convenience of those who pursue their careers as active managers.”
Prof William Sharpe, economist & Nobel Laureate | |
Passive fund managers aim to replicate or track the movement of a particular benchmark index. Therefore, they will only trade securities when required to, in order to match the index that they are tracking.
Passive fund managers have lower turnovers as they merely have to track the movements of their indices.
The average turnover of actively managed equity funds is in the region of 80% per annum and passive index funds is up to 20% per annum1. The effect of this is to add charges between 0.36% and 1.44% per annum.
Paul Myners, who led HM Treasury’s review of institutional investment in the UK, has been outspoken on this issue, estimating that the cost of actively trading UK equity portfolios is around £2.5 billion each year. He was quoted as saying:
 “There is no evidence that this huge payment – a tax on investors – yields a positive return.”
A £5,000 investment growing by 7% a year should grow to be worth £19,348 after 20 years (with no annual expenses). But if the annual expenses (or TER, see below) are just 1% these will drag down the performance to £16,036. An extreme example of a TER of 3% drags it down even further to only £10,956 - around £8,400 has been taken in charges.
There is substantial evidence to suggest that active fund management adds no benefit. In fact studies show that over 90% performance variation is derived from the 'asset allocation' (and 96% if a structured approach is adopted).
To quote from the FSA document ‘The Price of Retail Investing in the UK’ February 2004:
“… Active management does not enhance individual fund performance (though it does create benefits for the economy as a whole).”
and
“High explicit charges, on the other hand, do have a strong and predictable negative impact upon net performance”.
Life Insurance company statistics between 1987 and 1998:
“Over the entire sample period, the average market rate of return on the combined life office portfolio equals 8.45%, and the average return obtained by investors as a whole equals 4.44%.” 4
“Retail investors cannot easily measure the price of investing through the investment funds they must choose between, in part because a significant element of this price is mostly not disclosed at all.” 4
Clearly, there is more to investing than putting all of your money into a FTSE 100 tracker.
1‘Portfolio Turnover of UK Funds’ a Lipper Fitzrovia Consulting Report, Dec 2005
2 The Times, 15 February 2003
3 Portfolio Turnover of UK Funds’ a Lipper Fitzrovia Consulting Report, Dec 2005.
4 The Price of Retail Investing in the UK FSA Occasional Paper Series 6 by Kevin R James, Feb 20009
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Risk Warnings
The value of your investment can go down as well as up and past performance is no guarantee as to future performance.
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