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Asset Management

Asset Management

March 7th, 2008  · stk

Philip Coggan has written an excellent report on the asset management business, in this month's issue of "The Economist". An interview with the author is presented. If you invest, you owe it to yourself to hear what Philip has to say about fund managers, fees, performance and ETFs

Fund Managers do well - for themselves

Exchange Traded Funds (ETFs) and asset manager fees are again in the news. This time, in a special report on asset management titled, "Money for Old Hope". It appears in the March 1st issue of The Economist, a UK periodical.

I wrote about outrageous Canadian Mutual Fund Management Fees in early 2007. As a seasoned US investor, I was shocked to discover that Canadians pay the highest mutual fund management fees of any industrialized nation.

Imagine a business in which other people hand you their money to look after and pay you handsomely for doing so. Even better, your fees go up every year, even if you are hopeless at the job.

Philip Coggan
(on asset management)

As an individual investor, the best way to avoid shelling out your hard-earned money to greedy and non-performing mutual fund managers, is to invest in Exchange Traded Funds.

I'm glad to see that I'm not alone in my thinking. In the 14-page Economist Special Report on asset management, Philip Coggen examines the fund-management industry. In his discussion, Exchange Traded Funds are mentioned as being part of the solution in avoiding costly fees, which erode returns.

His description of the asset-management industry is very enlightening, as he outlines the perfect business: "Imagine such a business", he quips, "people hand you their money to look after and pay you handsomely for doing so." Sounds good, so far. But he sweetens the pot by saying, "Even better, your fees go up every year!" Wow. Cool. I want that job. Then he drops the bombshell by saying that you don't even have to be very good at your job and you can still get the monetary reward. Ouch!

The focus isn't on Canada, it's on the asset management industry at large. (In Canada, the amount that most investors pay toward management fees is criminal).

Anyone who wants to save more of their investment money owes it to themselves to read this article. For an audio interview with the author, a synopsis of this special report and a road map for higher investment returns .... read on.

Revenue from Management Fees - 15% Growth per Year

As outrageous as the Philip's description of the asset management industry might sound, that's exactly what happens. Fund management fees grow approximately 15% per year. This happens because the markets historically yield an 8% return per year and people's savings tend to grow at about 5-6% per year.

It's a good business and it's a BIG business, as experts estimate that the value of all professionally managed assets tallied to $64 trillion dollars, at the end of 2006.

If asset management is such a great business, why aren't competitors breaking into the fray and driving down fees?

It's a good question and part of the answer is that managers don't compete with one another based on fee prices. They sell their product based on performance, instead. "Don't focus on what it's costing you, look at the superior returns you're getting," is their argument.

While there is truth to this statement (i.e., I'd happily pay 3% to a fund manager, if my return were 25% per year), the sad fact, is that most fund managers fail to outperform the market, or the index against which their fund is measured. Even if they do beat the market, chances are they can't keep it up indefinitely. We've all heard the disclaimer - "past performance is not a guarantee of future performance". Many investors end up playing a costly game of chasing the best performing funds, only to invest after the manager's lucky streak.

Vanguard's former director, John Bogle, considered the Godfather of index funds, invented them because of their low fees and they outperformed most fund managers. For the 25-year period of 1980 to 2005, the S&P 500 index returned 12.3% per year. Over the same time period, the average stock mutual fund returned 10% per year and the average mutual fund investor (because of trying to time the market and chasing hot funds) earned only 7.3%. It's a strong case for index funds!

Investor portfolios may suffer from poor fund management decisions, by trying to time the market, by chasing hot funds and by market down-turns, but asset managers prosper regardless. There are many wealthy asset managers, and few wealthy investors.

Philip says, "The balance between the industry and its clients will not be redressed until investors learn that higher fees do not guarantee higher returns".

Up till now, fund managers have managed to keep up their higher fees, even in the face of the lower market returns of the past few years. They've also managed to fend off the challenge from index funds (passively managed mutual funds that track certain market indexes), partly because of salesmanship tactics by advisers, which directs investor money toward loaded funds.


A Solution - Exchange Traded Funds

If one looks at asset managers as an expensive department store (Neiman Marcus or Hudson Bay Company), they are now facing a new challenge from a low-cost store (Wal-mart or Zellers), in the form of Exchange Traded Funds (ETFs). An ETF is a very flexible, low-cost alternative to actively managed mutual funds and even lower cost index mutual funds.

Astute investors realize several facts:

  1. Past performance is not a guarantee of future performance.
  2. Most fund managers can't beat the broad market or index against which they're measured.
  3. Fund fees greatly reduce returns over the long haul.
  4. High fees doesn't always yield high returns.
  5. Index funds yield returns that beat most active funds, at a lower cost
  6. ETFs yield similar returns, at an even lower cost.
  7. There's no reason to line the pockets of an asset manager.

ETFs are attractive because they're flexible and inexpensive. ETFs are like an index mutual fund, but they're traded like a stock on an exchange. There are ETFs for almost every asset class. If you wanted to invest in Asian real estate, oil and gas, biotechnology or Taiwan, there's an ETF to do so.

It's up to the astute individual investor to realize the benefits of Exchange Traded Funds and use them to their advantage.

Ironically, one of the things that makes ETFs attractive, serves as a barrier to its promotion - low fees. Because ETFs don't provide commissions, no-one in the retail asset management business is selling them.

Philip Coggan says, "ETFs could be viewed as a set of Lego bricks from which an investor can assemble a do-it-yourself portfolio.".


Inverview with Philip Coggan

Philip Coggan's article goes on to cover more about the asset management industry, but I'm getting off at this stop. I've read all I need.

To achieve better-than-most-fund-manager results - invest in index funds or ETFs. To avoid paying unnecessary fund management fees - invest in low-fee index funds or ETFs

A good synopsis of the special report is contained in this 15-minute interview with Philip Coggan.


Further Reading

(1) Philip Coggan's Special Report - Read the report for yourself, online at the Economist website.

(2) Beware High-Fee ETFs - Read about avoiding those ETFs that have higher fees than other ETFs in this article.

(3) Vanguard is the ETF Cost Leader - Read about Vanguard's recent fee reductions in this Seeking Alpha article.

(4) ETF Investing Guide - Learn more about Exchange Traded Funds as an investment vehicle in this extensive Seeking Alpha guide.

(5) SPIVA Scorecard - Find out how actively managed funds stack up against their indexes in these quarterly reports by Standard & Poor.

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Updated: 25-Feb-2011
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1.flag Gary Comment
I look forward to the day when I have to worry about who looks after my money, at the moment I just keep spending it ! Its a lot less hassle ! but not a good long term investment ;)

2.flag Gary Comment
Hi Scott,
Loving this image gallery you have done.

Is this going to be for public use ? Any chance of the code for it please ?

3.flag stk Comment
Gary - I hear having money can be difficult, but I'd sure like to test out the theory! ;)

Funnily enough, I was thinking of doing a write up on the image gallery thing you linked, but it's awfully similar to something I did a couple of years ago.
4.flag Gary Comment
Oh yeh, I think that was before Yabba pointed me to your blogg !

If you don't mind I will have a look at your code and see what's under the bonnet to make it work. ;) Nowt like cheek huh !

Gz :)