Winning the costs war

We are beginning to be pleased with the way some things are going in the financial industry. The Retail Distribution Review, along with campaigns from us and other organisations for transparent and low-charging structures, is slowly bringing down costs.

If you want to invest purely in tracker funds (in which the manager tracks the market as a whole rather than trying to add value by picking the best stocks), you can now do so with Fidelity for just 0.07%. That's not bad at all.

Meanwhile, there is something of a backlash against fund managers whose funds behave like trackers, but charge as if they were wildly successful actively managed funds.

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In the US, several pension funds are considering class actions to recover fees paid to companies that have sold them 'benchmark huggers'. In the UK, says the Financial Times, a large law firm is in talks with "investors interested in taking legal action after buying index-hugging funds that posed as active products".

These cases may not succeed but at least they are a warning to the 40%-odd UK funds who fall into the index-hugging category, that investors are no longer tolerating the culture of gratuitous over-charging.

So, here's the big question. If you can buy a tracker for a near-negligible amount of money, is there any point in buying an active fund? Many people (including some MoneyWeek staff) think not the average active fund always underperforms, so you are better to go cheap passive and be done with it.

I am a little more agnostic. I'm a big fan of investment trusts and am prepared to be convinced that funds with small, high-conviction portfolios and intelligent, disciplined managers can outperform.

Look over the last five years, for example, and active funds have beaten passive by some distance. Over the last two years, says Richard Buxton of the Old Mutual UK Alpha Fund, they have even "soundly trounced" the index. Why? It is, it seems, all about the outperformance of mid-cap stocks against larger-cap stocks since 2013.

Passive funds, say Lowes Financial Management, will have a high weighting to FTSE 100 stocks (up 20% since the start of 2013) rather than FTSE 250 stocks (up 32%). Good active managers looking for value anomalies will have had the opposite.

But if that's the case, might active funds be about to have a problem? Perhaps, says Hector Kilpatrick of Cornelian Asset Managers. Five years of strong outperformance from active managers might suggest "a period of mean reversion is overdue" as mid cap-stocks fall (down 8% since February) and FTSE 100 giants rise.

Kilpatrick isn't convinced. Nor for that matter are Buxton or Lowes (they wouldn't be, would they?). But it might be something to consider before you succumb to Neil Woodford's stunning publicity campaign. Those of you looking for income should check the alternatives.