ECONOMY

Fees come first when assessing fund managers

Should all fund managers in the UK have skin in the game? And should they tell us just how much skin?

There are good reasons to believe they should. Think about how fund management companies make money. They all charge ad valorem — their fees are calculated as a percentage of the value of the assets they have under management and taken direct from your holdings every year.

That means that their main interest is not so much good performance in itself but in growing the assets under management: the more they manage the higher the absolute value of the percentage take.

They can do this in two ways: by performing well and by using a mixture of marketing and anxiety-inducing PR — you haven’t saved enough to retire on! — to persuade you to invest more.

Given this, you can see why it makes sense to want managers to hold units in their own funds: it makes sure they focus on both getting new money into the fund (which is entirely in their interest) and on making the fund perform well (which is also in our interest).

Good news then that this week the Interactive Investor platform has produced a short study into the skin in the game held by the managers of the funds in their Super 60 and Ace 40 lists of rated fund managers.

The data is fascinating for what it does tell us — 94 per cent of managers said they were invested in the fund they manage and 24 per cent said those investments came to more than £1m. 

That’s nice — or at least it’s the answer Interactive Investor would have been hoping for given that 77 per cent of their users say they would be “more likely to invest in a fund or investment trust if the manager is personally invested in it”.

But it is also interesting for what it does not tell us. Some 60 per cent of those polled preferred not to say how much the managers had in the funds and those that did say mostly did so inside ranges — £500,000 to £1m, for example.

This might be fine. There are also perfectly good reasons for leaving amounts out of the discussion. You could argue that a manager is already hugely exposed to their own fund (their career and hence long-term income depend on its performance) so it isn’t madly sensible for him or her to hold too much cash in it as well.

The manager might be better off hedging their exposure by holding a fund that does something they don’t do. Markets can be unkind.

That’s particularly the case if the manager is in something niche. Is it wise to have both your career and pension reliant on a small frontier markets fund for example?

And if they are, might it incentivise you to try to minimise the risk in the fund when your investors (who hold tiny parts of their portfolios in it) want you to max it out.

There’s also the problem of withdrawals: if you know a manager has a million in a fund — and that’s part of the reason you hold it — he’s going to end up having to tell you about his divorce, his school fees bills or the cost of his mother’s nursing home if he has to take it out. That seems unfair.

Finally, knowing the quantum of a manager’s investment isn’t really much use if you don’t know much about his net worth. Terry Smith of Fundsmith is open about having £250m in the funds he manages — “a substantial proportion of my wealth”. I can believe that — Smith is rich but £250m is a substantial proportion of anyone’s wealth.

But what if you know a manager has £50,000 in his fund? That’s chump change if they’ve been in the business for three decades running a reasonable sized fund that has even vaguely kept up with the market. But it could be a massive stretch — and huge vote of confidence — if they’re 35 with three kids and a whopping mortgage. Again, there’s a bit of oversharing required for the information to be relevant. None of this is simple.

All that said, I suspect there is one major reason why most fund houses might not want you to know how much their fund managers have invested: not because they mostly have too little, but because all too often, they have so much that it might give rise to awkward questions.

The key one is how on earth, in a business that is ostensibly highly competitive, can your profit margins be so high that you pay your managers so much that they can afford to have that much money in just one fund (no one holds just one fund…)?

The answer, as it has been for decades, is fees. These have been coming down bit by bit. Not many managers have the nerve to launch a fund with a fee of more than 1 per cent these days and the big houses make much of regular cuts.

This month Baillie Gifford cut its annual fee on the BG UK Alpha Fund from 0.55 per cent to 0.47 per cent and noted that this marks “the 15th occasion Baillie Gifford has reduced fees across one or more of its range of funds and investment trusts since 2013”. 

That’s nice. But Baillie Gifford has nearly $500bn under management. Charge 0.47 per cent on the lot (they don’t — it’s just an example) and your fee income is $2.35bn. Staff costs have historically made up around 56 per cent of fund management costs and the average profit margin for a fund management company is about 35 per cent. There’s real money knocking around here — something that translates into real wealth for fund managers.

On the plus side, we have rather more data on fees than we do on skin in the game — and it also isn’t nearly as complicated. Back in 2016, a study from Morningstar’s Russell Kinnel made it clear that costs are one of the better “proven predictors of future fund performance”

The cheapest funds were found to be “at least two to three times more likely to succeed than the priciest funds”. That was the case “across virtually every asset class and time period”, something, said Kinnel, that “clearly indicates that investors should keep cost in mind no matter what type of fund they are considering”. 

The lesson? Some things are nice to know but complicated to interpret (skin in the game). Other things are vital and simple to interpret (the impact of still-too-high fees). Maybe focus on the latter when you choose a fund.

Merryn Somerset Webb is editor-in-chief of MoneyWeek. The views expressed are personal; [email protected]; Twitter: @MerrynSW. She sits on a non-board investment governance committee at II and is a non-executive director of Baillie Gifford Shin Nippon investment trust.



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