Think of a product. Literally any product — razor blades, phones, TVs, cookers, caravans, anything. Then think back to what they were like 10 or 20 years ago. If you’re old enough, try to remember them 30 or 40 years ago. Chances are that either those products are of a significantly higher quality now than they were then, or they’re cheaper, or, in many cases, both. Partly as a result of better technology, partly plain and simple capitalism, consumers have never had it so good as they do today. Active funds.
Now think of the fund management industry. How has that changed over the years? True, there’s far more choice than there was in the past. But has more products meant better products or cheaper products? The answer has to be No.
Let’s look first at cost. In a recent interview with Morningstar, Jack Bogle compared the cost of investing today with what investors paid in 1951, the year he entered the industry. Then, a typical US equity fund would cost around 50 basis points or 0.5%. Today the average is more like 85 basis points — an increase of around 60%.
What many US investors don’t realise is that they are, in fact, the lucky ones. Everywhere else in the world fund fees are higher. Here in the UK, for example, a typical annual management fee is 0.75%; when you also factor in a platform charge of around 0.35%, fund custody and administration costs of about 0.17%, plus transaction costs, which usually add at least another 0.40%, the total comes to around 170 basis points. In other countries, fund fees are higher still.
But the crucial point is that the total amount of fees charged, in real terms, is vastly higher than in 1951. As Bogle told Morningstar, assets under management have gone from around $3 billion then to $16 trillion (yes, trillion) today. In a 2013 paper, Asset Management and the Growth of Finance, Burton Malkiel calculated that, between 1980 and 2010, the total expenses paid to equity fund managers in the US rose from $170.8 million to $24,143 billion — an increase of more than 141 times.
That staggering rise in income goes a long way to explaining why fund managers, who in 1980 earned about the same as teachers, doctors and accountants, can now command pay packages that rival those of film and sports stars.
Of course, there’s nothing wrong in paying people so much more if they’re genuinely adding that much more in value. The problem is that, in the case of asset managers, they’re not; indeed, quite the reverse. The track record of active fund managers was pretty unimpressive then, but it’s truly shocking now, as the SPIVA data produced by S&P Dow Jones Indices shows us time and again.
Fund management companies have, in short, enjoyed huge success in recent decades, simply by virtue of the fact that markets (and therefore asset values) have risen and also because, as global prosperity has gradually increased, people have had more to invest. The industry has become very rich, basically, not by creating wealth but by what economists call rent-seeking, by simply managing other people’s money.
These highly profitable firms have spent much of the proceeds on PR and advertising — on making themselves look good — and, as we’ve seen, on salaries and bonuses. But they haven’t shared their success with consumers, either through lower fees or better products. Indeed quite the reverse.
Again, think of the car that your parents or grandparents drove in 1980, when a cigarette lighter was considered a luxury feature. Would you buy the same car now at today’s prices? Of course you wouldn’t. So why buy a fund that will cost you a fortune in compounded fees and that, for all the shiny marketing, is even less likely to beat the index consistently than it was back then?