 It’s no secret that active fund managers are losing business to index funds, but they aren’t going down with a fight.
The big fund houses have always had large marketing budgets, and they’re drawing especially heavily on them now. As the US blogger Dan Solin wrote recently, the rational choice for investors is simply to “buy a globally diversified portfolio of low management fee index funds”. The problem is, “there’s a huge industry spending hundreds of millions of dollars annually to persuade you not to. They’ll say almost anything to persuade you to hand over your hard-earned money to them.” But are the marketers getting desperate? Are they trying too hard to stem the flow of money out of active funds and into passive ones? There are signs that they might be. A good example is a new campaign by Allianz Global Investors, the asset management branch of the German insurance company Allianz SE. Alliance GI executives have been touring the company’s 14 offices around the world, handing out brand new pairs of training shoes to its staff. It might sound like a joke but it isn’t. Apparently it's designed to emphasise AGI’s belief in active fund management. Bloomberg quotes Andreas Utermann, AGI’s chief executive officer, as saying: “Sneakers are just part of this brand relaunch. It’s not just the investment process that’s active, it’s the whole ethos of the firm and the way that we give advice.” It is, of course, a huge gimmick. It plays on the conjunction fallacy — the common assumption that doing something is better than doing nothing, and that hard work and effort inevitably lead to better outcomes. In fact, it’s the activity that’s the problem. As the former fund house executive Lord Myners recently admitted, most funds perform better when the managers aren’t working at all (i.e. when they’re on holiday). Why? Because of the constant buying and selling that active managers feel they have be doing to justify their fees and bonuses and to keep their jobs. Every trade they make adds to the cost of using them, and as studies have repeatedly shown, cost is the single most effective predictor of future fund performance. As well as redoubling its marketing efforts, Allianz GI is also revisiting its fee structures in an attempt to woo new customers. It recently cut the management fee on some of its funds in return for a performance fee it only charges if the fund beats its benchmark. “You only pay if we perform,” says Utermann. “Why wouldn’t that be a good deal?” Unfortunately, though, funds with performance fees are not the no-brainer the fund industry likes you to think they are. OK, you don’t get charged if the fund trails the index, but nor do you get reimbursed the money that you would have made if you’d invested in a low-cost index fund. After costs, active funds underperform the index most years, often by large margins, and the performance of AGI funds over the years has been little or no better than those of its peers. Over time, the cumulative effect of that underperformance will leave a big hole in your returns. Add to that the compounded management fee (even if it is reduced), and having to pay additional performance fees when the fund does beat the market, and it all makes a for a very bad deal for consumers. Like the training-shoe stunt, performance fees are just a gimmick. Compared to the US, the indexing revolution in the UK is only just beginning, and we can expect to see active managers become increasingly desperate to cling on to their market share. However tempting their offerings sound, you’re almost certainly better off steering clear.  An Englishman’s home is his castle, the saying goes. But in truth, the Scots, Welsh and Irish are just as keen on owning their own home. And for many Brits, one home is not enough; the level of buy-to-let and second home ownership is higher in the UK than almost anywhere else in the world.
Of course, people don’t just buy houses, flats and apartments to make money out of them. Homes bring enjoyment and utility to their owners that transcend financial considerations. But research has shown that most home buyers do see their purchase as a financial investment. Indeed, many now view property as a better and less risky investment than equities. What, then, does the evidence say about that? Each year, Professors Elroy Dimson, Paul Marsh and Mike Staunton of London Business School produce a publication for Credit Suisse called the Global Investment Returns Yearbook. In it they show how the different asset classes have performed over the very long term — specifically since 1900. There are several complications when assessing residential property as a financial investment. Most owner-occupiers, for instance, will need to take out a mortgage, and regardless of the size of the property, there are on-going maintenance costs involved in home ownership too. For landlords, those expenses are offset to some degree or other by rental outcome. But, in real terms, how much have house prices grown since 1900? You might be surprised at how low the average price rise, after inflation, actually is. Dimson, Marsh and Staunton analysed the data for 11 different countries and calculated the UK figure to be 1.8%. In Australia, where prices have grown fastest since the start of the twentieth century, the figure is 2.2%. The average annual price rise across all 11 counties is 1.3%, and in the United States it’s as low as 0.3%. How then, does that compare with returns from other asset classes? Well, equities have actually produced much higher returns houses. Since 1900, the 2018 Yearbook states, UK equities have returned an average of 5.5% (and the average return since 1968 is higher still, at 6.4%). Bonds have returned 1.8% over the last 118 years — in other words, the same as the growth in UK house prices — while government bonds, or gilts, returned an average of 1% a year. Again, all of these returns have been adjusted for inflation. Now let’s look at risk. “Housing has been less risky than equities,” the 2018 Yearbook states, “but the expression "safe as houses" is misleading.” As an example, Dimson, Marsh and Staunton cite the US, where “house prices fell by more than 36% in real terms from their late-2005 peak until their low in 2012”. The biggest numerical fall in UK house prices in recent history was between 1989 and 1993, when they dropped 20% across the country and by more than 30% in London. After the global financial crisis of 2007-08 they fell 13%. Of course, both equities have had a very good run. The bull market in global stocks is now more than nine years old. Despite that fall in prices immediately after the financial crash, UK houses have risen steadily in value since the mid-1990s and, according to the Office for National Statistics, houses now cost almost eight times average earnings. Nobody knows where the price of stocks or houses are heading next. As ever, the most sensible approach is to stay diversified and not to be over-exposed to either. If you own your own home, you are already heavily exposed to residential property. If you’re thinking of either trading up to a bigger house or investing in a second property, you need to think carefully whether the benefits outweigh the additional costs and risk involved. Whatever you do, though, don’t invest in property expecting to make a big financial gain, even over the long term. To quote Dimson, Marsh and Staunton: “Residential property should not be purchased with an exaggerated expectation of a large risk premium. It is equity assets that provide an expected reward for risk.” |
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