More than 40 years after writing his famous book Winning the Loser’s Game, Charley Ellis is still brimming with insights into the investing industry. But one observation stands out from our last interview, in Cambridge during the summer. Active fund managers, Charlie explained, are rather like doctors were in days gone by, in that they mean well but often end up doing more harm than good. Overtrading.
I confess to knowing very little about the history of medicine but I’m told that, even as late as the 1940s, iatrogenic disease — in other words, ill health caused by the actions of physicians — was in many cases more widespread than the original disease they were trying to address. Put another way, doctors often produced better results by doing less.
Many fund managers also do too much. Recent research by Paul Myners, London School of Economics chairman and a former fund manager himself, showed that about half of managers would deliver better returns if they didn’t trade at all.
Martin Gilbert, chairman of Aberdeen Asset Management, has expressed concern that too many managers have a “short-term mindset”, which encourages them to trade too much. Often their time horizon is three months or even less, he claims, when most of their clients are investing for far longer.
“Cutting in and out of investments is just playing fast and loose with other people’s money,” says Gilbert, “and the costs involved in this churn make it a mug’s game.”
The problem is that those costs are borne not by the manager but by the client. Moreover, because it’s impossible to know how often your chosen manager is going to trade in the future, the investor is unaware of what those charges are until they’ve been incurred.
Nor are these costs insubstantial. A new report by the Department of Work and Pensions shows that the cost of trading can double the cost of saving for retirement via a company pension scheme. Using figures quoted in the report, The Telegraph calculates that someone saving £800 a month into a pension for 25 years would lose £66,700 in transaction costs alone.
It suits the fund industry to keep transaction costs separate to the annual management charge, not least because of the added confusion it causes. As long as investors are in the dark about what they’re paying, and the charges are mentioned in the small print, asset management firms can keep extracting large sums without the client even noticing. In the case of company pensions, keeping the charges separate also means they can claim to be staying within the 0.75 charge cap applied by the Government when in fact they’re charging up to twice as much.
A DWP spokesman is quoted as saying: ”We recognise that transaction costs are complex and opaque and … we will review whether to include them in the charge cap in 2017.” That would certainly makes sense.
Another, more simple, solution that would benefit all investors, not just company scheme members, would be to make asset managers pay their own transaction costs and set their annual management charge accordingly. If that encourages fund managers to think more carefully before they place their trades, then that’s to be welcomed; as Lord Myners says, the less they buy and sell the higher their returns are likely to be.
There are all sorts of reasons why managers might be tempted to place more and bigger trades than is best for their clients, from keeping their jobs to qualifying for a bonus. For other managers, frequent buying and selling is just part of their active management style. Either way, how much they traded would be up them, the only difference being that the costs would come out of the company’s profits. Fund houses would be far more mindful of trading costs if they were footing the bill themselves.
Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.
