Jeff Salway: Biggest funds in the UK are consistently underperforming

AFTER sitting through the mediocrity that was the Calcutta Cup rugby game at Murrayfield last weekend, many Scotland supporters must’ve walked away questioning why they’d paid good money for the privilege.

As Hibs fans will know all too well, paying good money in return for consistently poor performances can be galling, especially in tough economic times. Yet millions more people would know that feeling if they took the time to look at how their investments were getting on.

Just a third of the funds available to private investors beat their benchmark last year, it has been estimated.

In a year of torrid sell-offs and the escalation of the eurozone crisis, the focus was on minimising losses, so widespread underperformance might be expected. But there are more than 1,800 unit trusts or open-ended investment companies on the market, and that’s before investment trusts enter the equation. That’s hundreds more funds than investors need. Yet the launches keep coming as the marketing men churn out new bandwagon-jumping products. Why do they do it? Because it’s easy money.... They can charge chunky fees and if the fund is marketed heavily enough – among advisers in particular – investor apathy means they can expect the money to keep rolling in.

As the biannual “spot the dog” report from Bestinvest and Chelsea Financial’s “relegation zone” research always show, some fund groups and funds are virtually permanent residents of the doghouse. And the regular inhabitants of the kennels include some of the biggest funds in the UK, meaning the companies managing them are raking in obscene levels of fees for failing to invest competently.

The latest research from Chelsea Financial, which focuses on consistency of performance over three-year periods, found that investors have almost half a billion pounds invested in the ten worst funds, some of which are lagging behind their peers by 35 per cent.

Performance fees have been raised as one counter to this, but these are of little advantage to investors. Typically, they involve the company charging a little extra if the fund produces returns above a certain watermark – yet in some cases that performance fee all but wipes out the gains that merited the added cost.

Surely, in an environment where most funds fail to hit their targets, investors would be more attracted to a system where their fee is reduced when performance is poor.

This does happen occasionally. Seven Investment Management last week “soft-launched” a new “unconstrained” fund unremarkable but for its fee structure, which includes a discount when performance is down. If at the end of each quarter the fund is level or up for the previous 12 months the fee remains unchanged. However, a discount of 25 basis points is applied if at the quarter end it is down for the last 12 months.

It’s not perfect; do investors pay lower fees if the total return beats the benchmark but the all-important dividend is slashed, for example? But, in an environment in which fund houses fail to justify the billions they rake in from investors, the time is ripe for an approach where they share the risk. Which means the chances of it catching on are unfortunately slim.

The smart boxes being used by a growing number of motor insurers are a prime example of a positive use of technology in determining premiums.

As Smart Money reveals today, the AA is the latest firm to begin using telematics in setting car insurance premiums, an innovation that will eventually make car insurance more affordable for responsible young drivers.

It contrasts starkly with the failure of travel insurers to reflect advances in medical diagnostics and treatment when judging the cover they offer to people with pre-existing medical conditions.

Last week’s Smart Money looked at the difficulties experienced by cancer sufferers in particular in securing affordable travel insurance. Of course insurers have to reflect risk in the premiums they charge, yet people several years into their recovery from cancer and given the so-called “all clear” are still being rejected by insurers.

The article prompted several readers to share their experiences of trying to get travel insurance after having suffered from medical conditions. The same issues come up every time – excessive hassle, inconsistency and lack of explanation. Insurers are profit-making businesses but there is no excuse for the massive variation in premiums offered to people who have had to jump through hoops for every single quote. There are more consistent ways of handling these cases and it’s incumbent on the insurance industry to use them.