Something for nothing

It occurred to us at recently that many discretionary managers are charging far too much for what they are actually delivering. Maybe we are slow on the uptake but we don’t seem to be the only ones. 

There are parallels with the Coke-Dasani disaster of 2004 when Coke were caught bottling tap water and selling it at a premium price (later actually managing to contaminate the water in their bottling process). Discretionary investment managers are doing something similar with passive funds at the moment. 

There is evidence ad nauseam that active managers have not been outperforming passive ones for the last decade. We have written on the subject before many times and justified our partial use of them by saying that in a market downturn they may protect you. 

Now 1% per annum for active might be worth paying instead of 0.2% for passive as ‘bad times’ protection but what if your active manager is using large amounts of passives?

This seems to be happening increasingly as discretionary managers accept that they can’t find fund managers who can outperform in the gilt, UK large cap and US large cap sectors etc. These sectors can make up a large part of a balanced portfolio. The discretionary manager has found what we all know which is that passive is the only way to go in major markets but, and here is the rub, they still charge their percentage across the whole portfolio. 

If you are a discretionary manager who buys large allocations to passive funds your only claim to investment management for this portion of your portfolio is that you can better asset allocate (weightings to each sector) than the next guy. Now there is also plenty of evidence that asset allocation drives most of the returns but none whatsoever that paying 1% per annum for this is worth it. 

So what should happen? Well some discretionary managers are running model portfolio services where their only annual charge is 0.25% per annum and if they use passives then the underlying fund charge savings are passed onto the client as a significant proportionate reduction in total costs. Some, however, charge as much as 2% per annum and are busy moving to cheaper funds and passives to make their overall costs look less nasty. It is this second set of asset managers (who generally distribute through their own tied advisers) who need to change to charging only for the value that they are adding. 

Ideally these big discretionary managers would admit that they add little value for the passive part of their portfolio and only charge their percentage on the active portion. Until this happens (and hell develops a ground frost) we will be selecting discretionary managers who charge fairly and have a conviction that they can outperform or protect our clients and not closet passives. We will then be buying a balancing passive allocation direct from the manufacturer thereby saving money for our clients. 

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