A market dominated by a few dozen vast funds does not necessarily deliver a better deal for the private investorby Andy Davis / August 21, 2014 / Leave a comment
In 2013 more than 90 per cent of the new money that investors put into the markets went to just 10 funds. When I stumbled upon this statistic, it seemed so extraordinary that I couldn’t help but doubt it—but a check using data from investment research firm Morningstar proved that it was true: 93 per cent of the net flows (offsetting redemptions against new investments) ended up in 10 funds, run by seven fund management firms.
The data is similar for 2012, and this year is shaping up the same way. You have to go back to 2008 to find the last time the 10 most popular funds did not claim an overwhelming share of new money. Admittedly, the composition of the top 10 does change a bit from year to year as some asset classes gain popularity and others fade, but the point broadly holds that the fund management industry is polarising. “If you have one of those funds you can make hay, but the rest will have to watch from the sidelines,” the global head of distribution at Henderson Global Investors told the Financial Times.
Should private investors care? After all, the UK has far too many funds—around 2,200 open-ended investment companies and unit trusts, according to Morningstar. The market is crowded, confusing for the public and full of me-too propositions set up in response to the latest marketing fad. If, say, three-quarters of these marginal and sub-scale funds were closed, it might be no bad thing.
But by the same token a market dominated by a few dozen vast funds does not necessarily deliver a better deal for the private investor. If the advisors and wealth managers and electronic “fund supermarkets” that channel money into the winning funds use their clout to drive down fees, that would help to improve matters, and there is some evidence it is happening.
But the observation from the Henderson executive—that the big players will “make hay”—seems to reveal the fundamental problem that concentrating the market will do nothing to address: these huge new winners will enjoy very significant economies of scale as their assets grow. It does not cost twice as much to manage £20bn as it does to manage £10bn, so your overheads as a fund manager do not to go up in line with your funds under management. Hence margins will expand and profits with them, of course.
As a private investor, there are not many things I can be sure of, but here’s one. I know that someone who has a portfolio valued at £500,000 in a fund charging 1 per cent a year will pay £5,000 for the service they receive, while someone with a portfolio valued at £100,000 in the same fund will pay £1,000 for exactly the same service. We pay fund managers on a percentage commission, the same way we pay estate agents. I don’t move house every year, yet the fund manager treats me as if I did. Nice work if you can get it.
Advocates of our new, highly concentrated investment fund market will argue that the big funds will gradually reduce their fees, offering the little people a better deal over time. That’s fine as far as it goes, but lower prices are not a substitute for proper transparency about what it actually costs to deliver this service and for charges that are based directly on those real costs. Until we have that, the leading fund managers will be handing private investors gains with one hand and taking them away with the other.