A myth has abounded for some time that low cost passive or index tracker funds are the best thing since sliced bread. Let’s face it the story is compelling. It’s difficult to find an active fund that consistently beats the index, most active funds perform worse than passive funds, charges are very low on passive funds so why bother with active funds?
Well as usual with most topics in life it’s only when you dig deeper that the truth starts to emerge. On the surface, it does look like active funds are unattractive. After all, nobody wants to pay higher charges and achieve below-average returns, do they?
The problem is that far too many active funds do perform poorly and charge fees that are too high. Many of them are closet tracker funds. In other words, they charge high fees but mainly invest in shares in an index such as the FTSE 100 Share Index which is precisely what a passive or index tracker fund does. Hence the term closet tracker fund. The fund industry has been subject to two damning reports by the FCA in recent years which focused on the sharp practices of active fund managers. These highly critical reports were fully justified.
A major problem is the conflict of interest most fund managers have between their main stakeholders namely their shareholders and their investors. Who is the winner in this game? Well, the shareholders of course. You see public companies have shareholders to satisfy so their focus is on building funds under management rather than excellent investment performance.
Fund managers such as Vanguard (a US mutual fund) and Baillie Gifford (a Scottish partnership) are notable exceptions precisely because they are not PLCs. Dare I say it, our associated company Minerva Money Management fits the same bracket because ours is a private limited company.
Vanguard promotes both active and passive funds but it is best known for its passive funds. Baillie Gifford has a number of excellently performing funds because its focus is clearly on investment performance rather than amassing funds under management. Having said that, both Vanguard and Baillie Gifford have attracted huge amounts of funds under management by putting investors first since they have no demanding shareholders to deal with.
When you strip out the large, underperforming active fund managers you start to find that there are many excellent active fund managers who do achieve superb investment returns that comfortably leave passive funds way behind. One of those top-performing fund managers is our very own Minerva Money Management fund the CCM Intelligent Wealth Fund which at the time of writing has achieved an excellent return of 35.7% over the last 12 months compared to its benchmark the IA Global Index which has only risen by 19.6% over the same period of time*.
Now I am not decrying passive funds altogether. They do have their place. If you are a self-investor and you do not have the time, inclination or skill to research active funds, then passive funds may be the best choice for you. However, you must bear in mind that a passive fund will always underperform its benchmark index because once you deduct charges, even if they are low, the fund will underperform its index. Why are charges so low? Well, it’s because there is no fund management involved. The fund manager simply buys the shares that constitute that index.
On the other hand, an active fund manager seeks to outperform the index by conducting lots of research and investing in shares that he or she believes will outperform the index. The best active fund managers like Minerva Money Management beat these index tracker funds by quite some margin in spite of their higher annual management charges.
So in my mind, it is illusory to believe that low cost passive funds are a better solution than well-managed active funds such as the CCM Intelligent Wealth Fund.
There is far too much focus by the media, investors, the FCA and even financial advisers on charges when the real focus should be on investing in the best performing active funds instead. Our fund achieved a return almost double that of the IA Global Index, 35.7% vs 19.6%, over the last 12 months with an above-average annual management charge of 1.2% compared to a typical index tracker fund which may charge about 0.2%. **
This example really puts things into perspective.
The bottom line is that in all aspects of life, including investments, you really do get what you pay for.*** You know it makes sense.
* Past performance is no guarantee of future results.
**The CCM Intelligent Wealth Fund’s return from 30/11/2020 to 30/11/2021 was 35.66%, from 30/11/2019 to 30/11/2020 it was 4.80% and from 30/11/2018 to 30/11/2019 it was 3.76% (source: FE Analytics).
*** The value of your investment can fall as well as rise and is not guaranteed. The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist. All information is based on our current understanding of taxation, legislation and regulations in the current tax year. Any levels and bases of and relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.