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Dog funds draining investor wealth

Philip Salter
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EVEN in the boom years, sticking with expensive fund managers that consistently fails to even beat its index is careless – during the bust years it is unforgivable. Yet Bestinvest has revealed in its biannual Spot the Dog report that £23.16bn of retail investors’ money is currently being misallocated in 94 underperforming dog funds, a 74 per cent increase since the last report in November 2010. Dog funds are defined as funds that have underperformed their benchmark in each of the last three years and cumulatively underperformed it by at least 10 per cent over the past three years.


OVER THE ODDS
Adrian Lowcock of Bestinvest says: “Once again it’s clear that the industry has little appetite to address abject underperformance,” adding “too few investors are willing to vote with their feet. Until they do,” he says, “it’s doubtful whether fund managers will ever be sufficiently motivated to clear up after their dogs.” Besides their underperformance, Bestinvest also reveals that investors have paid £348m in management charges over the last 12 months to these dog funds, equating to well over £1bn in charges over the three years upon which the report is based. As Patrick Connolly of AWD Chase de Vere says: “Many actively managed funds consistently underperform their benchmark index and investors unwittingly pay high charges for this poor performance.” The Retail Distribution Review (RDR) might push things in the right direction – despite the risk that RDR will price some investors out of the market for financial advice, it should also make charges more transparent, bringing down costs.


WHEN ACTIVE IS PASSIVE – OR WORSE
Even if your fund isn’t a Bestinvest dog, you could still be better off moving your cash. Jason Whitcombe of Evolve questions much of what passes for active management, describing many active funds as closet trackers that hug the index. Whitcombe asks: “Given that most actively managed funds fail to beat the index, is there any point in chasing alpha if the odds of actually achieving it are stacked against you?” He adds: “High charges leave you on the back foot from day one. In fact, what is fundamentally wrong with getting the return, beta, that capitalism provides us?”
For passive investment in the UK, Danny Cox of Hargreaves Lansdowne recommends HSBC’s All Share tracker, which charges 0.25 per cent, while Connolly and Lowcock both commend HSBC’s FTSE100 Index and Legal & General’s UK Index. Lowcock also puts forward the iShares FTSE100 for consideration. When it comes to the US, Connolly uses Legal & General’s US Index and HSBC’s American Index. Lowcock also mentions the latter, as well as the iShares S&P500 ETF and for emerging markets recommends the iShares MSCI Latin America ETF.

However, Connolly cautions that it “is also important to understand that even for a passive fund, cheapest is not always best.” He says: “Different passive funds use different techniques to track their target indices and if their strategy is not effective then a passive fund can potentially underperform or outperform significantly.” As always, thorough research or professional advice is a must

ACTIVE’S ADDED VALUE
Although the Spot the Dog report illustrates only too well that investors aren’t always getting what they pay for, there are circumstances when a highly paid active manager is worthy of their fee. Due to its size, the US market is more efficient than most, so US large cap fund managers find it hard to beat the index. In contrast, Lowcock says small caps and Asian and emerging market funds are particularly suited to active management. “There are some excellent and respected managers who add real expertise to our investment planning,” claims Stephen Barber of Selftrade.

Cox is also a believer in paying for good fund management and is happy to pay standard fees for that. He recommends Invesco Perpetual Income fund (1.5 per cent fees) and Aberdeen Emerging Markets fund (1.75 per cent fees). On active funds, Lowcock suggests the Schroder UK Core, adding that active emerging market funds are engaged in markets “where full cost active managers have been able to demonstrate good value.”

At the end of the nineteenth century, Oscar Wilde in The Picture of Dorian Gray censured: “Nowadays people know the price of everything and the value of nothing?” One hundred and twenty-one years later many people appear to know neither the price nor the value of their investments. Step one: get your diminishing wealth out of dog funds and move it into cheaper passive funds. Step two: research and move some investments into costlier funds if and when you are confident that the manager is deserving of the fees. But as Lowcock cautions, the most important thing is not to blindly follow any manager.