Jeff Prestridge: cull open-ended funds for the good of investors?

Our new columnist takes aim at investing firms that fail to offer value for money to consumers.

I read a wonderful article over the bank holiday weekend about the key role that good investment trusts can play in generating long-term wealth. 

It was written by veteran economist John Kay who has just stood down as senior independent director of Scottish Mortgage (LSE:SMT). 

That is the country’s largest investment trust and a constituent of the FTSE 100 Index, which incidentally is enjoying a rich vein of form (returns approaching 90% over the past year).

Kay knows his investment onions inside out and I implore any investor interested in maximising their wealth to read the piece that appeared in the Financial Times. But let me summarise.

Namely, we have too many investment funds in this country – and that many of the “too many” are poorly managed and do not provide investors with value for money. Charges in many cases are unjustifiably high – and no more than a one-way ticket for managers to get rich very quickly.

Ask yourself this simple question: have I ever met a poor fund manager? Poor as in financially poor, as opposed to being bad at their job?

I know the answer: a big, fat, no. I have been searching for more than 30 years and have yet to meet one who is on their uppers (plenty live near where I work in London’s swanky Kensington).

• Funds and trusts that have held up best in the dividend drought
• Property trusts and funds remain under the cosh

Kay believes that a majority of the 3,000 open-ended funds in this country should be culled. He is right. They serve little purpose other than to make fund managers and fund management groups rich. 

They should be merged with other funds possessing similar investment mandates that are run by better investment managers. The result would be a leaner and meaner funds industry that is more investor-friendly. Simultaneously, says Mr Kay, charges should be reduced.

Is this a pipe dream? Maybe, although the City regulator seems to be alert to the issue. Since last year, it has required fund management groups to assess on an annual basis the value for money that their funds deliver to investors. 

The resulting “value assessment” reports that investment managers must now put together are a step in the right direction. That said, some groups have gone a little overboard on the reporting, producing ridiculous tomes more than 400 pages thick (I’d choose Tolstoy’s War and Peace any time).

Although it is still early days, the analysis that the regulator is forcing fund groups to do is focusing investment houses’ collective minds. In some instances, poor value or investor unfairness is being recognised – and corrective action is being taken.

So, for example, some companies that run funds with multiple share classes are eliminating those classes with the highest fees (not before time). In other instances, internal reviews have been launched into chronically under-performing investment funds and change promised. 

Why it has taken the regulator’s intervention to trigger such actions is a moot point. Also, change is marginal – leading to suggestions that the regulator may start getting tough and fining those unwilling to push through change.

Kay is not so negative about investment trusts, although he believes that some suffer from the same vices that funds are plagued by (indifferent performance and unjustifiable charges). You could turn round and say: “Well, Kay worked for an investment trust, so he is bound to be kinder to them.”

Fair point, but the fact remains that investment trusts tend to be more investor-friendly than investment funds.

Why? Well, for a start they usually have lower charges and are overseen by independent boards whose role is to ensure the trusts are managed in the best interests of investors (shareholders). 

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In recent years, most boards – not all - have rightly become more challenging of management, either resulting in poorly performing fund managers being sacked or annual charges being trimmed back.

Second, in terms of income, investment trusts are more investor-kind than their fund counterparts. Unlike funds, trusts can squirrel away some of the income earned from their portfolios in the good years – and then pay it out to investors when company dividends are under extreme pressure (like now). 

It is because of this “smoothing” process that some trusts have delivered their shareholders more than 50 years of unbroken dividend growth.

Finally, given the fact that they are stock-market listed, investment trusts are always open for business – shares can always be bought and sold when the market is open. 

It means they do not have to shut up shop like some investment funds do when times get tough and there is not enough cash around to meet investor redemptions. 

Just think June 2019 and the “gating” of investment fund Woodford Equity Income. Or indeed now, with the suspension of dealings in a host of commercial property funds.

When it comes to investment trusts and unit trusts, I believe less is more.

Jeff Prestridge is personal finance editor of the Mail on Sunday. He is a freelance contributor and not a direct employee of interactive investor.