It is also obviously easier to validate ones fees if one advocates complex solutions with smart beta, venture capital and hedge funds favoured. The local anti-passive hysteria reached new lows earlier this year when one Continuing Professional Development (CPD) provider went further by publicly warning that advisers who recommended low cost passive solutions to their clients risked being replaced by Robo-advisers. Scary stuff!
On the other side of the high cost/low cost argument are academics, journalists (notably those working for the London Financial Times and the Economist) and the promoters of index funds who maintain that fees are important and, all other things being equal, the more you pay in fees the less you get in your pocket.
Today the battle seems more or less won by the low cost protagonists; according to the London Financial Times in the last twelve months Vanguard, the leading index fund manager, took in more new money than any other fund manager and index funds took in 20x more money than active funds.
Perhaps the biggest mis-step local fund managers have made in the active/passive battle however is their attempt to further gouge retail investors with patently unfair performance fees whereby they pay themselves a performance bonus on a share fund if they outperform a cash benchmark, for example.
Even Warren Buffett, arguably the world's most astute investor, has told his wife that when he dies she should invest in an index fund. In addition the last year has seen major institutional investors in the US and Europe publicly withdraw their support for hedge funds.
Adding fuel to the fire is the fact that the low cost model makes more sense the lower prospective returns are. Most experts reckon international shares are priced to return 6 per cent pa in the long term so paying 1-2 per cent pa in fees doesn't seem awfully bright, to put it mildly.
That's the international scene - what's happening in NZ? Things don't look so good here as passive funds have yet to get much traction and not many local academics have joined the debate. Indeed in the public domain the discussion is frequently dominated by fund managers who, surprise, argue that active management is the way to go.
We still have fund managers saying things like "when it comes to securing your investments future, cheapest doesn't necessarily mean best". There is an element of truth here in that low cost obviously doesn't guarantee "best" returns as skill is fleeting and luck is an important attribute in the fund management area. But several academic studies show definitively that in aggregate a low cost approach works and that every 1 per cent you pay in fees reduces returns by 1 per cent - notably a study by Mark Cahart in the Journal of Finance concluded that the more you pay in fees the lower the return.
Even fund research house Morningstar was quoted in the London Financial Times a few years back as saying that the single best indicator of future returns by asset class, were fees. Similarly a Visiting Fellow from the Pensions Institute of the Cass Business School said investors should focus on minimising fees.
Perhaps the biggest mis-step local fund managers have made in the active/passive battle however is their attempt to further gouge retail investors with patently unfair performance fees whereby they pay themselves a performance bonus on a share fund if they outperform a cash benchmark, for example.
Of course passive funds don't pay their computers bonuses in years when the stock market outperforms money in the bank therefore the short sighted move by many fund managers under the guise of aligning the interests of investors and managers simply makes passive funds look that much more attractive.
Commonsense tells you that high fees aren't a great idea however such is the extent of the misinformation, obfuscation and lack of regulation locally that NZ investors in average cost share funds assume the risk of equities but, after fees, in the long run, will be left with the return of cash deposits. Not a great result.
As we saw a couple of weeks ago, the average fee on a growth oriented KiwiSaver fund is a huge 1.64 per cent pa. There is no way that any institution in NZ would ever pay that sort of fee to a fund manager and if institutions can't afford to pay it mum and dad can't either.
But things can get a lot worse than that; a new client came to see my firm this week and they were paying total annual fees of 2.85 per cent pa to their financial advisor/fund manager. This fee virtually guarantees no real return in a normal investment environment.
Remember that bonds yield about 4 per cent and with shares returning 6 per cent that is a weighted average return of no more than 6 per cent for a growth portfolio with a modest bond weighting. Despite this the financial planning firm optimistically forecast a long term return of 8.2 per cent pa pre-tax, post fees and an income yield of 4.5 per cent pa when the reality is likely to be, at best, 3 per cent pa and 1.5 per cent respectively.
This firm is regulated by the FMA who have an objective of ensuring fairness etc etc. Earning less than bank deposits whilst taking on the risk of shares doesn't seem awfully fair and its worth noting that the UK version of the FMA has banned financial advisors from making optimistic return forecasts. Clearly a lot more work required here in the regulatory field.
Note that this article is not advocating passive funds over active. Best practice as evidenced by the portfolios of pension funds locally and around the world is generally a mix of both low cost active and passive funds on the basis that we need active funds to keep stockmarkets efficient and we need passive funds to keep active fund managers efficient.
What is clear however is that the hysterical ravings of CPD providers and many others adds no value to the discussion and everybody, including the FMA, needs to take a more constructive approach if the financial advisory industry is to regain the confidence of retail investors.
Perhaps a good way of focusing the minds of regulators on the cost issue would be to compel all the senior executives to invest their superannuation and KiwiSaver funds through the highest cost provider in each asset class. Then we might get some action.
Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent Sheather may have a financial interest in the companies mentioned in this article.
