Findings from the FCA’s Asset Management Market Study

Back in the day active fund managers were all there were – you called the stockbroker who managed your portfolio. But then came the Big Bang. Computers were brought into fund management and the automated tracker fund was born. As technology became progressively better, many started to become critical of the continuing role of active fund managers. Now that role has been questioned by no less an organisation than the Financial Conduct Authority.

An introduction to active and index fund management

An Index Investment is an investment strategy that follows the performance of a particular stock index. It’s usually favoured for long-term investments due to the assumption than most indexes increase in value over time. An index investment will often be referred to as a tracker fund, as it tracks a particular stock market index automatically, buying and selling commodities in proportion to those represented on the index.

An Index Investment is an investment strategy that follows the performance of a particular stock index.

Using an active investment fund is often seen as more likely to produce a rapid yield. Such investment vehicles will typically employ a fund manager charging for their services, who will seek to make informed investment decisions in order to outperform the market.

The most effective management techniques will exploit the inefficiencies inherent in the market by purchasing undervalued stocks and short-selling those that are overvalued. Typically, such a fund will run with a set of investment goals, or benchmarks, which are set by the customer.

The FCA’s review of active management

The FCA report on asset management was stinging in its judgement. When costs are taken into account, overall, the report demonstrated that actively managed funds rarely outperform their benchmark. Those used by retail investors in particular are prone to under-perform, with those favoured by institutional investors and pension schemes rarely performing significantly better than the benchmark.

It may seem natural for an investor to choose a fund with higher charges in the expectation of better results, but this is rarely the case. Evidence shows no clear relationship between price and performance in actively managed funds.

Evidence shows no clear relationship between price and performance in actively managed funds.

So there we are. The regulator has confirmed what many investors already suspected, that actively managed funds make big money for the managers but rarely for the investors. Indeed, the FCA study discovered that active and index funds achieved similar net returns over the period 2003–2015.

In fact, based on historical data the average active manager would need to outperform the market by more than 12.5% in order to surpass the performance of the index investment.

Asset Management Ratings

To many, the obvious response to this might be that the Asset Manager Ratings will give a better indication of the quality of actively managed funds. Ratings agencies such as Morningstar certainly ensure that rated managers meet minimum quality and operational standards, but there’s no indication that they’re helping investors to identify better performing funds.

Analysis of share class performance on best buy lists shows that across all categories they tend to perform better than non-recommended funds. However, the net performance after charges of such products still generally offers little significant gain beyond the benchmark.

Those classes awarded a 5-star rating by Morningstar, however, were shown to earn greater excess returns than other share classes, so the rating agencies are not entirely without worth.

Pricing

Here again, the regulator has spelled out what many have known for a long time. Despite the huge growth in active fund managers and assets under management (AUM), the price of active funds remains stubbornly constant.

Index investment charges, in contrast, have plunged, with almost 50% wiped off the average cost in the last three years alone. The average active fund now costs seven times the amount of the average index investment.

The average active fund now costs seven times the amount of the average index investment.

Worse still, once AUM passes £100m the prices do not change significantly, indicating that investors are not making their due gains through economies of scale. Clearly, either asset managers are ineffectual or they’re not aligning their own interests with those of their investors.

Profitability

All this begs the question of who is reaping the rewards of actively managed funds? Once again, the FCA is critical.

For larger firms, revenue increases with AUM. Why wouldn’t it? Costs also increase, but at a slower rate meaning that profits increase steadily. However, these profits are not being shared downwards with investors, instead benefitting only the managers.

So for the small investor at least it seems quite clear that, as with so many other fields of employment, the human fund manager is in very real danger of being displaced by far more effective computerised traders.

We understand that active and index fund fund management can seem complicated. Whether you’re seriously considering your investment opportunities or would just like to find out more information about the subject, we can help. Our team is happy to discuss your options and opportunities, as well as our stance on the active vs. index investments scale.

For independent advice, expertly delivered, simply call us on 01993 772 467  or get in touch online.

Jonathan

About the Author

Jon is a highly qualified and experienced Chartered Financial Planner and Certified Financial Planner with over 27 years’ experience. He loves working with clients who are passionate about getting the most out of life and feels his job is to support them living life to the fullest. Read more from Jonathan...
This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. Past performance is not indicative of future results and no representation is made that the stated results will be replicated.
Terrific meeting, many thanks. We always drive back from meetings with you wishing we'd met you and Dom years ago - but at least we're with you now! RB

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