Behavioural flaws in investment choice are no nation’s preserve
• UK study shows that while past performance is top of mind many are ignorant about fees
So much of our financial regulation is coming from the UK. It is curious that the authorities have caught the Eurocentric regulatory bug far more than their counterparts under white rule.
So you can be sure that the South African Financial Services Board (FSB) has taken a close look at a thick document known as the Asset Management Market Study. It was put out by the UK Financial Conduct Authority (FCA), which is the model for the FSB after the proposed Twin Peaks reform.
One chapter was headlined How do investors choose between asset managers? Don’t be under any illusion that the British retail public has greater insight and sophistication — the behavioural flaws in picking funds are common right across the world. The FCA says that for competition to work effectively in asset management, retail and institutional investors need to be able to access, assess and act on information that allows them to identify the products and asset managers that best meet their objectives. In theory, it should be quite an efficient market as clients can switch within a day to a more suitable fund.
Investors surveyed by the FCA didn’t have a very surprising view of what counts as value for money — it is return achieved — and I can’t imagine that ever not being the prime source of value for a unit trust. Price paid, risk taken and the quality of any additional services provided by the asset manager applies primarily to institutional clients. An exception might be when fund managers start providing Discovery smoothies as a perk.
Increasingly, retail clients make use of best-buy lists and third-party ratings and some of the less sophisticated even ask financial advisers. The ratings put out by Profile Data, an excellent home-grown South African business, can certainly help investors sort the wheat from the chaff. Linked investment service providers (Lisps) such as Glacier also put out useful research. But only a small minority of financial advisers here are genuinely knowledgeable about funds.
When direct-to-consumer platforms give fund recommendations in the UK it leads, on average, to a 29% increase in that fund’s assets. SA’s Lisps remain staunchly intermediated and some institutions were hugely embarrassed by the failure of direct-to-consumer platforms such as Old Mutual’s Funds Net and Liberty’s MyLife back in 2000, which literally got only a handful of clients.
The FCA found that only a small proportion of the funds in the best-buy lists on platforms (the British name for Lisps) were index funds and before January 2014 not a single passive fund made it on to any of the lists. And they make up only 6.9% of funds on these lists today. Enough to make a passive fund fanatic such as the Treasury’s Ismail Momoniat hot under the collar. The FCA even argues that the Morningstar star system discriminates against passive funds, rarely awarding them five stars. Yet there is no conclusive evidence that these five-star funds will outperform index funds over the next five years.
In spite of all the warnings, investors are still heavily influenced by past performance and are attracted to five-star funds, which have almost always done well in the short term. Reputation, a proxy for brand, was mentioned frequently.
Past performance isn’t very helpful when survivorship bias is considered. Over the past 10 years more than 60% of the existing Europe equity funds have closed, along with 55% of the US equity funds and 54% of UK equity funds. They were either merged or liquidated.
While investors will often know the rankings and past performance of the fund, they will not be too well informed about fees. More than half the retail investor base did not believe it was paying charges, and this is with fee disclosure on all relevant documents.
For institutional investors such as pension fund trustees the management fee is the single most important issue in the UK. If I am honest, as a trustee I would have to say the investment consultant’s recommendation is more important, yet this is only halfway down the list in the UK. The marketing pitch and marketing materials are put at the bottom of the list. There can’t be too many marketers over there with the flair of Sygnia’s Magda Wierzycka, who can sell ice to the Eskimos. Too much British false modesty and understatement, no doubt.
One way to choose managers would be to pick one of the winners in an industry award show. The Morningstar awards, given out this week, reward funds that perform well in bull and bear markets; they are the unit trust awards without the bull. In spite of what the FCA in London said, passive funds do win these awards and this year it was the turn of the BlackRock global equity tracker.
Two very good long-term houses won the awards this time, Prudential for the larger range and Foord for the smaller range. Prudential is more palatable for many investors as it is consistent — and that is not just an advertising message. I wouldn’t hesitate to recommend its funds, such as the Equity, Balanced and Inflation Plus.
Foord investors probably need to be made of sterner stuff — it is well known that founder Dave Foord models himself on the cartoon character Hagar the Horrible (or maybe it’s the other way round). From time to time this fanatical yachtsman has had short bursts of shocking performance, but if you plan to lock money away for 20 years, it would be tough to find many funds with higher growth potential than Foord Flexible.
Beware of some of the flyby-night winners who don’t have the resources to repeat a good performance consistently.
Keep an eye out for some of the top performers at the awards, such as Truffle and PSG, which both have well-rounded teams. You can’t go too far wrong if you look through the options offered by Nedgroup Investments, which uses a range of mid-sized managers for its best-of-breed programme.
IN SPITE OF ALL THE WARNINGS, INVESTORS ARE STILL HEAVILY INFLUENCED BY PAST PERFORMANCE AND ARE ATTRACTED TO FIVE-STAR FUNDS