Opinion

Fund managers: you get monkeys whatever fees you pay

When it comes to fund managers, the adage that “if you pay peanuts, you get monkeys” is broken, says Matthew Lynn – you get monkeys whatever you pay.

950_MW_P18_City-View

The vogue within the investment markets has been to pay for performance. If you pay peanuts, you get monkeys, has become the mainstream view, and asset managers have started to change their fee structure to build in a performance element. It started with the hedge funds a generation ago, with 20% of the profits typically going straight to the manager, and since then it has shifted into more mainstream funds offered to smaller investors. In the UK, close on 100 unit trusts now have some form of performance fee built into them and so do many hundreds more across Europe. They are common among investment trusts as well. Each time, the argument for them is the same. Sure, they will cost some money, but the incentives will also improve performance, and so investors will come out ahead.

But what if you pay big money instead of peanuts, and still get monkeys? A study from the London Business School looked at all the mutual funds offered for sale across the European Union, plus Norway and Switzerland, over a decade. Of those, 7% charged some form of performance fee, typically 20% of any profits made in excess of a chosen benchmark.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

And how did they do? Not terribly well. The performance-fee funds actually did worse than their rivals by between 50 and 70 basis points per year. The funds that did especially badly were those that either set no specific benchmark, or else one that was easy to beat. Just as seriously, those funds also had on average higher expense ratios than their rivals. To put it in simple terms, investors were paying a lot more money for results that were below average. That is hardly a great outcome.

Something similar has been observed over the years among the hedge funds as well. Although a few funds achieve spectacular results at least for a few years and get a lot of headlines, most have not done very well at all. According to the Credit Suisse Hedge Fund index, from 1994 to 2018 a passive S&P 500 tracker outperformed every major hedge-fund strategy by 2.25% in annualised returns. The hotshot managers may well have huge incentives to beat the market. But it generally doesn't happen. In fact, as with unit trusts and mutual funds, not only do they not justify the fee, but it was actually better to choose a fund with no incentive fees built into it at all.

Advertisement
Advertisement - Article continues below

Why the incentives don't work

Second, it is very difficult to beat the market. One or two investors can perform better for a few years, and the occasional exceptional one can do so for a whole career. But most will simply do a bit better than the index one year, a little worse the next. Markets are not perfectly efficient, but they are very close to it. An incentive might make a difference to a sales manager, who can simply work harder to beat his target and earn his bonus. But it possibly doesn't make any difference to an asset manager. He simply cannot beat the market, any more than he can walk on water.

The conclusion for investors, however, is a simple one. With a very few exceptions, it is never worth paying someone else to manage your money. Either do it yourself, or else choose a low-cost tracker fund, where at least you will replicate the performance of the index, and at very low cost. The asset-management industry is very good at coming up with new ways of charging its clients there is plenty of "incentive" for that but it never works. And it is always smarter to avoid it.

Advertisement

Recommended

Visit/504054/the-power-of-mean-reversion
Funds

The power of mean reversion

When it comes to investing in funds, don’t chase the top performers – look for the cheapest ones.
1 Apr 2019
Visit/503809/investing-in-funds-the-most-important-number-to-look-at-before-you-buy
Funds

The most important number to look at before you buy any fund

Many investors get distracted by past performance when they buy a fund. But there’s something else to consider that will have a much bigger influence …
22 Mar 2019
Visit/520115/investment-trusts-the-cinderella-of-investment-arrives-at-the-ball
Funds

Investment trusts: the Cinderella of investment arrives at the ball

Investors should look beyond the market noise of a single year and examine the bigger picture. Max King explains what we can learn from 25 years of in…
8 Jan 2020
Visit/520292/passive-investing-etfs-wont-cause-the-next-market-crash
Stock markets

The boom in passive investing won’t cause the next crash

Passive investment funds such as ETFs are now such a fundamental part of financial markets that some people worry that they will spark the next crash.…
7 Jan 2020

Most Popular

Visit/currencies/600665/currency-corner-new-zealand-dollar-kiwi-vs-us-dollar
Currencies

Currency Corner: how is the New Zealand dollar doing against its US counterpart?

The New Zealand dollar has been doing well against the US dollar in recent months, but has started to wobble a little. Is it still a buy? Dominic Fris…
20 Jan 2020
Visit/investments/stocks-and-shares/share-tips/600653/indias-small-and-mid-cap-stocks-are-set-for-big
Share tips

India’s small and mid-cap stocks are set for big gains – here are three to buy now

Each week, a professional investor tells us where he’d put his money. This week: David Cornell of the India Capital Growth Fund highlights three favou…
20 Jan 2020
Visit/investments/stocks-and-shares/share-tips/600636/class-acts-going-cheap-buy-into-europes-best
Share tips

Class acts going cheap: buy into Europe’s best bargains

Value investing appears to be making a comeback, while shares on this side of the Atlantic are more appealing on metrics such as price/earnings ratios…
16 Jan 2020
Visit/investments/stocks-and-shares/share-tips/600641/share-tips-of-the-week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
17 Jan 2020