Last Updated: 31 January 2023
Are active fund managers beginning to set up competitive alternatives to index funds and ETFs?
The high fees charged by most fund managers have been instrumental in driving the popularity of cheap, passively managed tracker funds. Now it looks as though some in the active fund industry are responding to the challenge.
As an example of a new, lower-cost fund from a well-known name in the market, Terry Smith’s new firm, Fundsmith, offers a managed equity portfolio with a management fee of 1% per annum. With other costs factored in, the total expense ratio (TER) comes to around 1.25%.
That’s still more expensive than ETFs – the average European equity exchange-traded fund has an annual TER of 0.4%, according to BlackRock. But Smith’s fund is substantially cheaper than the average actively managed equity fund in Europe, which charges 1.8% a year.
If’s Fundsmith’s launch is anything to go by, however, the gap between the cost of provision of active and passive funds is narrowing.
Smith is making a careful marketing pitch to position his firm both as an alternative to index funds and to active funds that hug their benchmark too closely (“no closet indexing”, “we want to diverge from benchmarks”), but also to some of the more pernicious practices of the fund management industry in general (“no punitive fee structures and no overtrading”).
Most powerfully, Smith argues against performance fees. These, he says, are a mechanism to enrich managers at the expense of investors. A US$1,000 investment in Berkshire Hathaway shares in 1965, when Warren Buffett began running it, would have been worth US$4.3 million at the end of 2009, Smith points out. However, Smith adds, had Buffett set Berkshire up as a hedge fund and charged a standard hedge fund fee (2% a year, plus 20% of any gains), the vast majority (US$4 million) of the return would have accrued to Buffett as manager, with less than 10%, about US$300,000, remaining for investors.
Fundsmith is also steering clients gently away from using a financial advisor by charging an extra 0.5% for investing via an intermediary (the extra fee is used to compensate the advisor concerned). “We have no objection to intermediaries per se, but using them does add to your and our costs and may cause communication issues”, Fundsmith says. That’s hardly a recommendation to use an IFA.
And a key selling point is ease of access. You can invest in the fund via the firm’s website in three simple stages. There’s no need to go to a fund supermarket, for example (the most popular route to buy an active fund for many retail investors). But it’s also clearly easier to put money into Fundsmith than to buy an ETF (for which you need a brokerage account and some knowledge of how to place stock market trades).
Fundsmith is undoubtedly one to watch. The firm’s chief executive and main backer has built a personal fortune after a series of well-timed career moves, some of which seemed like professional suicide at the time. Most famously, he issued a “sell” recommendation on his employer, Barclays’ stock in the late 1980s, then got himself sacked from UBS in 1992 for criticising the overaggressive accounting policy of several of his firm’s investment banking clients (in his book, “Accounting for Growth”). Smith then started his own firm and made a great success of it.
Terry Smith’s new venture seeks primarily to gain assets from the active sector of the fund management industry, which Smith describes as “broken”. That’s also still where the vast majority of investors’ money resides. However, the entry of well-respected stock-pickers into the fund business in a low-cost way should keep passive fund providers on their toes as well.