With a growing focus on charges in the investment space, GAM's Charles Hepworth argues that cost and value for money are not always the same thing.
At its core, the aim of the Retail Distribution Review (RDR) was to align adviser and client interests, bringing transparency to fee structures. This led advisers to question several other business practices, including whether to outsource, how to service smaller clients and how to demonstrate value.
But perhaps the most striking consequence of the RDR is the increased focus on fund total expense ratios (TERs). This is not surprising considering the changes to charging structures and rising regulatory costs for advisers. However, although we should be aware of fees and charges, portfolios should not be built around costs at the expense of satisfying client objectives.
Levelling the product playing field
Looking purely at costs can sometimes mean losing sight of value. The ban on commission has significantly skewed inflows towards passive exchange traded funds (ETFs), with strategies tracking large developed market benchmarks for a few basis points.
Is the industry’s TER obsession healthy?
To give an indication of the scale of the passive market, BlackRock, which owns the ETF provider iShares, recently reported that the global ETF industry received record-breaking inflows of $262.7bn in 2012 and reached the milestone of $2trn in assets under management in January this year. While the passive industry took 19 years to reach $1trn, it is predicted it will take only a further four years to double in size.
Benefits of active managers
While we do see a role for beta products in asset allocation, markets can be inefficient and cumbersome, and passive funds often hold the largest stocks, rather than the ones that offer the most opportunity.
Looking at this in practice, the current fixed income market provides a good example of how active managers can add value. Despite making up significant proportions of cautious investors’ portfolios, today’s bond market offers an unappetising combination of high prices and record-low yields.
On a forward-looking basis, the picture looks worse, with an interest rate increase seeming almost inevitable at some point in the future. The likely outcome for many government bondholders is negative returns. We believe that, in this environment, absolute return strategies are far more attractive than government bonds and provide additional portfolio stability.
While this approach is more costly, and increases the TER, performance analysis illustrates that it does add value. Those invested in a global bond index would have lost 4% over the last year.
In contrast, an unconstrained fixed income manager following an absolute return approach, utilising derivatives to improve the duration risk of a portfolio, generated 2% over the same period, net of fees. Of course, this performance is not spectacular but the opportunity cost of not being exposed to a truly active manager is significant.
At its core, finance is an industry like any other and its customers want value for money. However, it is important that we do not confuse value with cheapness. Carefully selected premium products fully justify a higher price when their use is necessary. After all, it is very easy to create a cheap portfolio but much harder to create a good one. So, instead of simply questioning ‘what is the TER?’ we should be really be considering ‘what makes up the TER?’
The following funds are examples of managers who we believe add true value:
Alken Absolute Return Europe: Managed by Nicholas Walewski, an experienced and highly successful value manager in European equities, the fund adopts a dynamic but disciplined investment approach using a long-short strategy.
The focus is on quality companies and avoiding market excesses. It has generated strong returns year-to-date, gaining 17.8% in sterling terms, according to Thomson Reuters.
Odey Odyssey: The fund is managed by Tim Bond, adopting a global macro investment style across all asset classes and regions. Tim has a strong record of macro forecasting and strategy, which is evident through the fund’s positioning. Year-to-date, the sterling institutional share class has gained 17.2%, according to Thomson Reuters.
CC Japan Alpha: Probably the best performing of the three, this fund, managed by Jonathan Dobson, has been well placed to benefit from the Japanese equity market rally in the first half of the year. However, this understates the level of outperformance Dobson has achieved.
Being a true alpha manager and, arguably, the best in the business, the fund has eclipsed the broader market indices, returning 54.5% year-to-date (GBP class), according to Thomson Reuters. Compare this to the Topix index return of 23.5% in sterling terms, and the argument for seeking value over low cost is obvious.
An ambitious objective
'Something completely new'
'Illusion of control'
Reasons to be cheerful
Total investment reaches £9m