These kind of organisations have always had one major selling point - they offer to take away the effort of managing your own portfolios, while allegedly hiring experts to find the best investments. They also claim to spread the risk by holding more individual investments than may be practical for any one person, and give you the opportunity to invest in asset classes that you could not do directly (as in private equity, venture capital investments, and exotic instruments that hedge funds seem to like).

One advantage they certainly have is that the management costs of some funds are exceedingly low (such as 0.2% per annum of the fund value), which can be even lower than the costs you might incur by direct investment assuming you value your own time above zero. On the other hand, other funds have quite high costs (up to 5% per annum in extreme cases) so you clearly need to be wary on this score. In addition some of the costs are hidden - for example read this article from an Update Newsletter in 2003 regarding fund turnover and the problem of "churning": Fund Turnover. The government has tried in the past to introduce some standards for simple funds with maximum charges called "CAT Standards" - see the following UKSA response on this subject: CAT_Standards_1998. In 2007 we raised concerns about the growing trend of fund managers to raise their charges - and particularly criticised a change proposed at Graphite Capital - see the following press release that we issued for more information: Press041_Graphite.

But is there any evidence that professional fund managers do better than the market? Basically the answer is no. Very few fund managers exceed the market indices in any one year (primarily because the market indices have no transaction costs built into the index). Some beat the indices purely by chance, particularly if they have a high risk, concentrated portfolio, but the chance of them repeating this from one year to another appears to be remote. It seems that the vast majority of fund managers perform no better than chance, or at least no better than their peers.

Note that one advantage that these collective funds have over the private individual is that they pay no capital gains tax on gains within the fund, whereas you and I pay tax on every deal made. Clearly this is discrimination in favour of institutional investment and UKSA would like to see this changed. Back in 1997, UKSA proposed an alternative structure to give individuals more control, which is covered in the following documents: CGT_Account and CGT_Account_Letter.

It is important to emphasise that not all collective funds are the same. They vary greatly in terms of focus, likely yield, volatility and risk. For example, investment trusts can increase both their performance and their risk by gearing up (ie. borrowing money to invest). Indeed they can have very complex financial structures which finally came home to roost with split capital investment trusts where a number of funds were set up in the 1990s which even the professionals did not seem to understand. See the following submission by UKSA on such funds: Investment_Trusts_Split_Capital_2002.

Other notes by UKSA related to investment trusts are:

Investment_Trusts_Share_BuyBacks_2001

Investment_Trusts_Share_BuyBacks_1999

Investment_Trusts_VAT_2003

To see historic performance data on collective funds, and other comparative information such as yields, a useful publication is Money Management (published by the Financial Times group and aimed primarily at IFAs but certainly of interest to anyone who takes a professional interest in investment matters) - see www.ftadviser.com. Or go to TrustNet (www.trustnet.com) for on-line information.

If you want to review the merits of passive versus active investment strategies, we suggest you read this article from our Update Newsletter: Passive_or_Active_Investment.

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