Price vs. Value

Thoughts from GemCap UK Chief Executive Stuart Alexander on price vs. value, and some of the misconceptions and miscommunications between Fund Managers and Investors.

The old adage that we know the price of everything but we don’t know the value of anything is so true in the Funds industry. I have spent the last 35 years having to defend the Active Funds industry for what is often seen as excessive in so many ways. Whilst that is often very true in some exceptional situations, the vast majority of firms do well but aren’t all driving Ferraris and drinking Dom Perignon with their Caviar blinis. Back in the heady early days of the Funds industry from the mid-eighties to the mid-nineties there were very few actual Fund Management businesses compared to today and as result some Asset Managers were able to take significant market share with some sizeable asset growth. The fees were still very rich compared to today and no one really commented on it. It was what it was. You paid the price as there was nothing to compare it with.

Things starting to significantly change in the mid-nineties with the advent of the platforms such as Cofunds and Funds Network. More platforms came on board and over time the whole value chain has transformed beyond recognition. It accelerated post the RDR implementation of 2013 and has continued at a pace with more and more pricing pressures coming from the industry and in particular competitive passive products. Today we find ourselves in a Funds industry that is more fundamentally different from the Distribution channel than it has ever been. The actual Fund Managers haven’t changed other than there are many more firms around with a plethora of products available. Some would say too many, but I will come back to that.

A couple of weeks ago I decided to listen into some “Legends” of the industry on an OCTO Members webinar. Richard Philbin, Jon JB Becket and Mark Dampier were not grilled but more lightly toasted about a number of points. Mainly fees for Funds, performance fees and that old chestnut: the number of underperforming funds surviving. What struck me about the conversation was the confusion about how Fund charges are made up: the difference between OCF and TER, for example, as well as many not appreciating the true costs for running a Fund from the point of a Fund Manager. There seems to be a view that Fund Managers are ripping people off and that there is no alignment of interest between them and investors. What I find perplexing is why this debate needs to be had, or at least is this conversation the right one we should be having? Fund Managers need investors and investors need Fund Managers, passive and active, in order to develop the returns they are seeking as advised by their Investment Advisers etc. So why the apparent conflict? Lack of understanding is often the reason that conflicts take place in the first place.

When it comes to running a Fund, the one thing investors need to understand is that a Fund is not cheap to run. On paper it may look simple, and thus why the rate that is charged looks disproportionate to what actually is paid by investors. The list is very long from regulatory costs, capital costs, legal, audit, CoSec, platform onboarding and don’t get me started on distribution costs such as the dissemination of data to providers who charge the Fund to receive the data and put on their website. Figure that one out!  There are so many firms that feed off a Fund that it becomes eye watering when you start to list them. Investors may end up paying more because another investor needs the Fund on a particular platform or that the data has to be shown on a particular website. Technology does not allow us today to strip out these costs at an investor level and I doubt that will ever happen – but you never know.

Performance fees was another topic they touched on and for a rare moment I agreed with Mr Dampier and also scarily Peter Hargreaves. It was some years ago when he had a real go at me about Performance Fees and to be fair he had a point but being a fellow Northerner I was struggling to back down – dangerous with Mr Hargreaves! Suffice to say his point and one that Mark also opines on is that the IM fee is the performance fee and that if an IM performs well, then the assets grow and their ad valoreum fee means they benefit. Creating an extra level of performance fee on top can build up a sense of over-fishing and for some investors the alignment of interest is lost; for others, they see it as an IM as doing their best to produce excellent returns because everyone benefits whilst others may see it as too much risk… gold and glory come to mind.

The other argument that seems to be persistent in certain circles is the plethora of underperforming funds and why they continue to exist. Basic maths will tell you that 50% of funds will underperform the average so do they get culled and then the next 50% of the top 50% gets culled and so on? Of course not – but why do they survive? Simply, investors stay in them. Why? Due to inertia or because they are trapped? Inertia is often the main reason as investors may not realise or monitor. Advisers should be monitoring and actioning against these poor funds by disinvesting. By that action the Fund becomes too small to be profitable and natural selection will take place. However the vast majority of those trapped are sadly at the whim of a Pension fund that allocates to an internal fund, and it can be in the interest of the Asset Manager to allocate to that asset class or sector even though they are poor in that, unless they use external funds.

So yes, there are some pretty poor managers hidden in some of the big Managers who get away with underperforming relative to peers and markets. These lifers are invariably benchmark plus and if they underperform one year they will make it up the next year… probably. But they survive because they are allowed to. No Adviser or Private Client is exposed to them and probably doesn’t even know who they are. Where advice is involved or there is direct contact then those Managers have got nowhere to hide and invariably, they get their just desserts. Many Funds will have orphan clients from eons ago and, as we see nearly every week with more Fund closures, there is a drive from Investment Managers to rationalise non-competitive products. Some would argue that this is on the back of the Assessment of Value drive from the regulator, but the reality is that a lot of Funds are closed down each year or merged away based on economics.

Investment Managers need to remain competitive, and their shop windows are their funds. Some use Fund Farming techniques where they always have Funds available no matter what cycle we are in, and others will just stick to one asset class or style to create a definite competitive advantage. We all have our favourites in certain asset classes and we believe that the firm is excellent in that space but not necessarily in another asset class until they poach a star from somewhere else. It is very rare when an Investor/Fund Selector will choose all Funds from one IM but will rather stick with one or two. In short we should get IMs to focus on what they are good at and on the whole Boutiques do that whereas the larger Managers try and be all things to all men which leads to the huge proliferation of new Funds. In recent times the growth of ESG from IMs has been almost tidal wave-like in the delivery, with everyone suddenly being amazing in the space. Maybe I’m just a cynical old bugger but I say stick to what you are good at and stop trying to be good at everything. Even a modern athlete sticks at a maximum of 7 events in the Heptahlon!

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