We are now more than a year into the post-RDR world. Otherwise known as the Retail Distribution Review, new regulation introduced by the Financial Conduct Authority (FCA) has fundamentally changed the investment services industry from commission-based to fee-based, with a view to making pricing more transparent and value more apparent.
The battle between active and passive fund management has also flared up again. RDR has certainly highlighted cost. Passive has always been far cheaper than active management, though the good news for consumers is that on the whole we have seen charges fall for both types of fund. Furthermore, not only have prices fallen on unit trusts, but also for investment trusts, as RDR suddenly exposed the true costs of the latter.
There has been an increasing fixation on price over the past few years. Aside from resulting in lower charges, more transparency has made it easier to measure and compare prices. Value, on the other hand, is harder to perceive. At this juncture, I would like to highlight an argument many passive investors often wheel out.
I am not against passive funds; they often make a great deal of sense, especially when a good actively managed equivalent is not available. If a simple passive fund gets savers investing for the first time and increases general investment knowledge, that is even better. In recent years the idea has evolved that investing in a passive portfolio must surely be better than investing in a more expensive active fund. The argument to supposedly back this point is that no investor can pick stocks successfully or, if they can, it is impossible to identify those stocks in advance – success is more luck than judgement. Therefore, it is better to pay less and follow the performance of an index, although passive funds will always underperform their index, due to the effect of charges, small though those charges are.
The belief is value can be added instead through asset allocation, by focusing on specific sectors or geographical areas likely to do well. The problem with this argument is that asset allocation is as difficult, if not more difficult, than picking individual stocks.
The past five years have shown how difficult asset allocation can be. Many commentators have been bearish (or at least too defensive). They have made asset allocation calls based on a possible Chinese hard landing; various geo-political risks; a possible exit from the euro currency bloc; and bond bubbles. None of these issues materialised and global stock and bond markets continued to rise. The opportunity to add value through the bond markets, particularly in financial bonds, and by investing in unfashionable areas such as Europe, has passed many asset allocators by.
This is also true of many active fund managers, and many feel the fool for missing the rally in certain markets. However, the low-cost portfolios I have seen, from Alan Miller at SCM and John Redwood at Charles Stanley Pan Asset Capital, don't seem to show they have added any real value.
The Pan Asset Defensive fund is up 1.9 per cent since launch in October 2010, against 15 per cent for the average fund in the IMA Mixed Investment 0-35% Shares sector, which I view as the fairest comparative sector. The SCM Bond Reserve portfolio has made 13.1 per cent since launch in June 2011, against 17.7 per cent for the IMA £ Corporate Bond sector. Both have underperformed close competitors who have higher charges. I would point out each of these fund's internal benchmarks is to outperform cash – but this seems pretty undemanding for what are risky portfolios.
Cost alone should not be the basis of an investment decision. Choosing the cheapest investment is not a guarantee to make money, but neither is choosing the most expensive.
Where does this leave investors? My view is to spread your eggs with a few managers or funds you like, then make as few decisions as necessary. Asset allocation may sound easy (with hindsight!), but making investment decisions based on economic data, geo-political concerns and even valuations, are more difficult than most investors believe. Occasionally rebalancing your portfolio should one asset class have a tremendous run, or if another sector has a bad run and is worth topping up, makes sense. Beyond that, leave it alone. Cost is a consideration; but like most things in life, cost alone should not be the final arbitrator.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds in this column, visit www.hl.co.ukReuse content