Wellian Weekly 27.07.2020

Some “Things” Wrong with Unit Trust / OEICs – Part II

In a previous article I wrote about how frustrating it is and long it takes for a fund of funds manager with an outsourced ACD to get an account set up and ultimately be able to trade in collective investments. On the other hand, if I wanted to buy an Investment Trust or ETF then this deal can be completed as soon as the deal ticket was completed and sent and this is a major risk for the unit trust / OEIC industry.  I’m sure we’ve all seen the charts showing that “x” years ago the average investor stayed invested in the same fund for “x” years, whereas today the average investor stays invested for “x” months. If it is difficult to get access in the first place due to admin backlogs, why keep trying?

Another “issue” I have with funds relates to pricing and perceived value. Admittedly this is an incredibly subjective argument, but one I feel needs closer attention.

Until fairly recently, if a unit trust / OEIC was launched, it pretty much came with a 75bp charge – regardless of the asset class the fund was investing in, regardless of the investment style, regardless of the promoter, regardless of the geography, regardless of the size of the universe etc etc….. We as fund buyers bought what was on offer. Unless we could buy the institutional class (minimum £x million) we got the same price as Miss Jones’s £50 a month ISA bought through a platform.

In many ways this feels like a cartel. If I went to a car dealership and wanted a 4 door saloon with alloy wheels, leather seats, aircon, metallic paint a 2 litre turbo-charged engine I’d be offered a large number of competing vehicles, but they all wouldn’t be priced exactly the same.  If I went into a supermarket and wanted a tin of baked beans, they all wouldn’t be the same price either….  In terms of Annual Management Charges you pay the same regardless of how well the fund performed and this seems wrong too.

I am not against performance fees. In fact, I quite like them. After all, if a fund manager has the ability to beat a pre-defined benchmark, what is wrong with rewarding them? Fund managers being rewarded for asset gathering is not the same as fund managers being rewarded for outperformance.  Having performance fees can actually help with fund managers wanting to operate with capacity constraints and this can have knock-on benefits to liquidity in certain parts of the market for instance.

Performance fees can actually give fund management companies extra leeway when it comes to their annual management fees too…  I’m fairly sure a fund management company that launched a fund with a 20bp AMC fund but with a performance fee would take a lot of money under management from the hedge fund investor as well as the passive one. If for instance the fund launched was a UK Equity fund benchmarked against the FTSE All Share +1% (after fees) then the performance fee would only kick-in after the manager has proven themselves as being able to add value…

I also have issues relating to added fees on top of the AMC.  Why does it cost the same to administer a £25,000,000 investment as a £1,000 one? We subscribe to Financial Express and when you compare the different share class offerings from the same fund, the OCF remarkably remains the same. It seems like the fund has a cost of running and that just gets divided across the different share classes and the only benefit for a larger investment is a lower AMC. How many investors are in the £25,000,000 share class compared to the standard retail class? Just feels unfair to me in that the institutional investor is bearing a much higher burden on the ongoing running cost of dealing at the benefit of the retail investor.

Fund management groups are waking up to the idea that they can differentiate according to AMCs – this has been driven – in the main – by passive funds and their incredibly low AMCs and by the regulators desire to see margins squeezed. As a major fund buyer, I regularly get offered access to a “founder” share class for new fund launches and this tends to be a heavily discounted price which we have previously taken advantage of.  But, lots of our AUM is on platforms, and this founder class is unavailable to us in many situations due to restrictions from the platforms if our assets cannot be ring-fenced. In reality the platforms are hindering our ability to reduce costs for our clients.

Don’t get me wrong – I think there are managers out there that offer a premium service / product / fund and can, potentially charge a premium price. (Performance fees or capacity controlled funds for instance.) I also realise that manages can add value not just through performance numbers. For example, if a fund manager achieves the same return as the benchmark, but with less volatility, or more yield, or via a different investment approach, or with a different tracking error this could be perceived as adding value and could be priced differently.

Innovation has been attempted in the past though: I remember seeing a fund management group (First State) rebate fees on a select number of funds if they underperformed, and a couple of years ago Fidelity for instance tried to bring in “fulcrum pricing” to a big media splash, but unfortunately it fell by the wayside. Why did these attempts at innovation fail?  Partly due to poor systems / complexity of the undertaking / admin headaches – partly due to the way regulation has developed. No longer can rebates be allowed for instance – even if the rebate is in the form of new units (if a client invests their full ISA allowance and then the fund underperforms and the client has £x worth of extra units bought, the client has therefore invested more than the allotted amount and all of a sudden the client is in breach, or for example what do you do if a rebate splits tax years, or if you have sold or bought part way through the year…)

The second derivative of the innovation needs to be considered when it comes to pricing; it is complex and regularly just falls away, at the product development stage so what happens? Everyone prices the same as the competition and pricing seems to get ignored.  When passive funds first launched, they were about 20bp and now (depending on the market) 5bp is not unusual. The cut in cost from 20bp to 10bp is 50%, and from 10bp to 5bp is another 50%.  In the last few years, how many existing active funds have cut their price by these sorts of numbers to compete?  I know the cost of managing an active fund is different to managing a passive fund, due to the old human / computer interface, but why are the OCFs so different too in this space? Is it any wonder why passive funds are eating the lunch of the active manager?

A low price doesn’t mean a good product, and a high price doesn’t mean a bad product. A low price doesn’t automatically mean a large fund size and a large fund size doesn’t automatically mean the fund management company is making excess profits. Open-ended funds shouldn’t mean an unlimited fund size.

 

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