There has been much media coverage recently about the excessive charges levied by asset managers that are able to enjoy profit margins of almost 40%, which is among the highest of publicly quoted companies. The damning report by the Financial Conduct Authority, which was published last month, concluded that not only were charges too high but that performance of the average fund was disappointing and often underperformed the main stock market indices.
To the lay investor, how can the professionals get it so consistently wrong and what is the alternative to committing one’s savings to funds with sub-index returns and paying high fees for the privilege?
Seeking the advice of experts
The savings and investment industry is complex and it is only natural that people should choose to seek the advice of experienced experts. After all, if you wanted to improve your golf game or needed complex keyhole surgery you would consult a golf professional or experienced surgeon confident in the knowledge that they would provide a level of service that required years of training and practice.
However, although asset managers and stockbrokers also have years of qualification before acting on behalf of clients, the results are very different. Fund managers often underperform their benchmark and stock broker analysts recommend, appropriately for this time of year, many turkeys!
The reason for the poor returns offered by professionals is not through lack of effort and hard work. On the contrary, the hours worked in the City are long and arduous and many of the analysts know the companies they are researching better than their own management.
The challenge facing all investors is that because the stock market is so efficient it is extremely difficult to outperform it on a consistent basis. The great value investor, Benjamin Graham, nicknamed the index ‘Mr Market’ and paid it the utmost respect knowing how difficult the market was to beat. Certainly something an investor will require to obtain above average returns is patience which is an attribute that is often not available to fund managers and analysts who are judged and remunerated on short time frames of as little as 3 months.
How the market reacts to major events
To understand how the stock market works it is necessary to think of it as a discounting mechanism that efficiently takes into account all available information and prices it accordingly (known as the Efficient Markets Hypothesis).
