Make sure your active fund manager earns her fee

FOR years, the debate has raged over whether hedge funds and actively managed funds – in which managers pick assets individually as opposed to simply tracking an index – are worth their high fees. Now, research by Saltus Partners suggests that the current economic climate makes it particularly difficult for active funds to differentiate themselves.

Saltus took 21 different kinds of investment, ranging from oil to US treasuries to small cap companies, and compared the degree of correlation in their returns in the last ten years versus the last three months. They found that across the board, returns are more correlated with one another now than they have been over the last decade.

This means that it is harder for active managers to pick assets that will outperform the average benchmark – and consequently harder for them to earn their premium fees. Actively managed funds typically charge 1-1.5 per cent in fees plus a levy of around 20 per cent on returns above a stated watermark (this is down from 4 and 40 per cent in the heyday of hedge funds). This compares with a normal passive fund fee of around 0.25-0.5 per cent.

Shiv Taneja of Cerulli Associates says that in the current climate, “Active managers are really having to earn their keep and a large number are not doing well at all”. This is borne out by data compiled by Hedge Fund Research: its global hedge fund index shows that, year-to-date, the average return has been just 0.18 per cent.

Investors can still hedge by diversifying the assets to which they are exposed, but the usefulness of the middle man who promises to deliver better hedges than the market average has diminished. Saltus’ research finds, for example, that in the past three months, UK 10-year treasuries have been almost perfectly negatively correlated with UK large cap stocks, which means that investors do not need a fund manager to tell them which shares will make a good hedge.

The reason for this correlative strength, says Saltus Partners’ Dan Kemp is that “everyone has become entirely macro-focused because they realise that the share price of a fantastic company doing all the right things can be completely overwhelmed by the background noise”. In other words, in a fragile economic environment, investors are adopting a more top-down, macro strategy of moving in and out of sectors or asset classes wholesale, rather than stock-picking.

But Kemp believes that instead of veering away from active management in bad times, investors should use this fallow period in which fees are relatively low (when many funds are below their watermark level) to find talented managers with strategies that could bear fruit in the future. Which means that investors should be subjecting their premium-cost fund managers to more scrutiny than ever.