Among fund selectors, and even on occasion among media, an undue focus on past performance, particularly short-term past performance, is all too common. This is understandable to an extent—performance is the one concrete metric by which advisers will be held to account by their clients. Unfortunately for investors and advisers relying on it, past performance is not a particularly accurate indicator of future results.
Cost and Stewardship: Key Factors for Fund Investors
There are more salient items for fund selectors to focus on. One factor to look at is cost, as I previously explained with respect to bond funds. Fund fees represent fixed negative alpha in an uncertain world. It isn’t everything, but you ignore it at your peril.
(As an aside, the Retail Distribution Review (RDR) should have a salutary impact on investors’ ability to assess these costs by helping them clearly discern the amount they are paying for fund management versus the amount they are paying for financial advice.)
The issue that I want to focus on here, however, is one that often gets short shrift: stewardship. Stewardship refers to the extent to which an asset manager acts as a steward of capital, as opposed to acting purely as an entity manufacturing fees for itself out of investors’ money. As my managing director likes to say, firms that focus on salesmanship ask: ‘if we launch a new fund today, how much of it could we sell?’ Firms focused on stewardship, however, ask the much more relevant question: ‘if I sell this fund to clients today, what will those clients think of me five or ten years on?’ Firms with good stewardship practices try to align their interests with those of fund investors. They understand that the way to build a durable business is to ensure clients have a good experience with their brand. For investors, this has the salutary effect of knowing the fund manager is working hard for you.
Factors that indicate a high level of stewardship can be hard for advisers to investigate, mainly because the regulator does little to ensure relevant information is provided
Factors that indicate a high level of stewardship can be hard for advisers to investigate, mainly because the regulator does little to ensure relevant information is provided. The FSA doesn’t even require funds to name their managers, let alone report on more subtle factors such as manager compensation that bear directly on alignment of interest. In both cases, fund investors are treated much worse than equity investors, who are required to be told who is running a company and details of their compensation. There is no credible reason for the difference in treatment. However, it‘s worth noting two regulatory developments that should at least help promote good stewardship practices:
Firstly, the FSA has started to take the industry to task for not having appropriate safeguards with respect to managing conflicts of interest. In a paper released in November called Conflicts of interest between asset managers and their customers, the regulator wrote: “We concluded that most of the firms visited could not demonstrate that customers avoid inappropriate costs and have fair access to all suitable investment opportunities. We found that the attitude towards customers established by senior management best explained why some firms managed conflicts well and others badly.” It’s still early days, but the regulator’s focus on this issue, and more specifically, its direct link to senior management’s “attitude towards customers” will at least shine a brighter light on stewardship practices.
The other bright spot comes courtesy of the AIFM Directive (Alternative Investment Fund Managers Directive), which is going to require that at least 50% of managers’ variable compensation be paid in shares of the funds they manage. This is one of the most direct ways to align interests of managers with fund investors—by ensuring they have “skin in the game”. Whether the requirement expands beyond alternatives remains to be seen, though some reports say this is likely. We can only hope.
The original version of this article was published in Investment Adviser, which is part of the FT Group.
