Fund managers destroy value. Here's the proof.
First consider how Warren Buffett, the world's greatest investor, has grown money. If you'd invested $1,000 in Buffett's holding company, Berkshire Hathaway, in 1965 it would be worth $4.3m today. That's what can happen if you take the trouble to identify really strong businesses and stick with them.
But now hear this. Warren Buffett is a modest man. He's lived in the same small house in Omaha, Nebraska, for fifty years. He likes nothing better than a burger for his lunch washed down by a glass of cherry Coke.
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Buffett is the very opposite of today's greedy fund managers.
And here's the point. If Warren Buffett had run his investment company the way hedge funds do and charged the same fees, his investors would have just $300,000. The missing $4m would have gone straight into Buffett's bank account.
How fund managers get away with this rotten deal
Chelsea Financial Services has classified 101 funds (which, worryingly, it used to recommend to its clients) as 'duds.' And Peter Hargreaves of Hargreaves Lansdown, has this to say: "Thousands of people have invested their savings in funds run by managers who don't know what they are doing. The average unit trust has not beaten the index. They are run by banks, building societies and life companies and are seriously cr*p."
I absolutely agree. And it's even more galling that fund managers are doing very well out of this 'cr*p' performance. Just consider this. 28% of retail investment funds run by banks have, over the last ten years, deducted more in fees than they have delivered in returns. That's outrageous!
Here then, is the deal, offered by the fund management industry: "We will take a nice slice of your money every year, come what may, enough to keep us in the caviar and champagne life-style that we believe is our right. And if there is any profit left over at the end of the year we will credit this to your account."
This has always been a rotten deal. But three things have allowed it to continue.
First, few people realize just how much of their money is being creamed off by fund managers. Second, most people put their fund statement out of sight and out of mind. They'd rather ignore it than think about how they could improve things. And the third thing is that in the bull market, most funds managed to scrape a positive return even after excessive charges. So they get away with it.
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But to use one of Warren Buffett's masterful aphorisms, "when the tide recedes you know who has been swimming naked". And as the tide of asset prices has turned in the last few years, we find that the masters of the universe were not so masterful after all.
Dismal returns and damning academic studies have revealed that hedge funds and multi-manager funds do nothing for investors and everything for the fund manager's bank balance.
With the whole fund management industry under pressure, individual reputations are coming down with a thump. Just look at oh-so-smart hedge fund manager Hugh Hendry, whose Agriculture Fund has just been dropped by Hargreaves Lansdown after a pathetic three-year return of 1.7%. I almost choked when he explained that "hedge funds are designed to help you out when times get tough and more conventional investment strategies fail".
Listen to the investment wisdom of Lily Allen
That deal has since spectacularly failed, leaving Hands staring at a $2bn loss. For this he blames a banker friend for rushing him into the deal. But the real cause was his own greed, lack of due diligence and apparent ignorance of the problems of the music industry.
Lily saw it coming. 'I hate Terra Firma,' she said. 'They're w--kers and they don't know what they're doing. They will fail.'
She was right. Financiers and fund managers are not smart. They're just greedy opportunists out to separate us from our money. Do they deserve to rip huge chunks out of your savings? Should you trust your money to them at all? I don't think so.
I've been saying so for years. That's why readers of Red Hot Penny Shares have done the sensible thing, buying their own shares and running their own portfolios. They have by-passed the fund management industry altogether. And without those heavy fees, they have the potential to be much better off by investing in great small companies for the long term as part of a diversified portfolio.
Recently I sent the readers of my premium service a penny share play that could be about to take off, quite literally...
This article was first published on 2 November in Tom Bulford's twice-weekly small-cap investment email The Penny Sleuth.
Red Hot Penny Shares is a regulated product issued by MoneyWeek Ltd. Past performance and forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be volatile, relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you've bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3780.
Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund.
Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.
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