In the light of Neil Woodford’s fall from grace, Woody Allen’s quip that ‘A stockbroker is someone who invests your money until it’s all gone’ has seldom seemed so apt. But is his miserable story uncommon?
Star investment managers have often built careers on past performance, enabling them to charge top-notch fees, only for their performance to take a dive. For example, Justin Urquhart Stewart enjoys a high profile as a business commentator but the performance of many of the funds in the investment company he co-founded, Seven Investment Management, has been disappointing. His 7IM Moderately Adventurous Fund has returned just 5 per cent per annum over the past five years, but charges 1.44 per cent in fees. In the same period, the Legal & General UK Index Trust returned 6.18 per cent p.a. with fees of just 0.1 per cent.
Not that L&G are much better when it comes to actively managed funds. Their UK Alpha fund also charges 1.53 per cent in fees but has lost around 30 per cent of its value over two years under the stewardship of Rod Oscroft.
There was much chatter before 31 October that fund manager Crispin Odey was backing Boris Johnson to deliver a hard Brexit in order to profit by short-selling UK shares. If he did, it was a bet that failed, but it wouldn’t be the first time. Many funds under his management are currently bearing significant losses, down as much as 27 per cent in the past year (although things have turned more to his advantage in the past fortnight thanks to an event he couldn’t possibly have foreseen: the coronavirus outbreak). Annual charges of up to 3 per cent of the value of his funds (and a 0.5 per cent exit fee) add insult to injury.
This is not a new problem. In 1940, Fred Schwed Jr wrote a book entitled Where Are the Customers’ Yachts? prompted by a trip to a New York marina to admire the boats belonging to Wall Street brokers. Why should it be, he asked, that providing financial advice should be so much more profitable than receiving it? Take Goldman Sachs, which earns a fortune from advising its clients but which on several occasions has been found buying assets it advised clients to sell.
Why should it be, asked Fred Schwed, that giving financial advice should be so much more profitable than taking it?
There are two certainties with fund managers: firstly, that good luck will not last, and secondly, that they will continue to charge high fees whatever happens. In 2008, Warren Buffett wagered $500,000 for charity that no investment professional could select a portfolio of five hedge funds that could match the performance of the low-cost Vanguard S&P 500 index fund over a decade. Ted Seides, an investment manager, took on the bet and selected five hedge funds, creating in effect a ‘fund of funds’. Remarkably, his investments returned 2.2 per cent compared to 7.1 per cent for the index fund. It wasn’t even sunk by a single bad decision — none of the hedge funds would have beaten the tracker individually. No wonder, when it was estimated that some 60 per cent of the hedge-fund gains were swallowed up in management fees.
Unlike other money managers, Buffett appears to be reconciled to the rise of passive investing. Perhaps it stems from his own difficulties in making good investment decisions with the huge sums in his care. Over five years, B stock in Berkshire Hathaway, his investment company, has more or less matched the S&P 500 index, hardly the stuff of legends.
In his 2013 letter to investors he stated his advice to the trustee of his fund after his death: ‘Put 10 per cent of the cash in short-term government bonds and 90 per cent in a very low-cost S&P 500 index fund…I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.’
We are far too quick to praise managers who outperform the market without stopping to ask: could their performance be nothing more than a statistical quirk? Consider that if there are 5,000 fund managers at any one time and that, purely by chance, half will outperform a benchmark each year, then as many as 1,250 will outperform for three years running. There will be more than 300 who beat the index over five years and there will be one who ends up on the right side of the line every single year for 12 consecutive years. It’s a statistical inevitability that someone in the vast pool of managers becomes a ‘legend’ through chance alone. The garlands that they receive will also be enough to see them through rare occasions when they inexplicably fall short.
It can be seen as a variant of an old con where scammers would send 10,000 people opposing stock tips. They would send a second letter to those for whom the tip had been accurate. This would continue until some ‘lucky’ folk had received five letters. The victims would be convinced to turn over their money to the con artists, who would promptly vanish.
It’s hard not to see the parallel with the Woodford fund. During his 25-year tenure at Invesco Perpetual, his High Income and Income funds achieved annualised growth of 13.1 per cent and 12.4 per cent. When he left Invesco Perpetual in 2014 to strike out on his own, it was no wonder that so many investors were keen to follow him to his Woodford Equity Income fund, enabling him to raise £1.7 billion of investment within a fortnight. Five years later, investors are facing losing up to three quarters of their money — while, astonishingly, Woodford has continued to take massive fees: in 2017-18 alone, Woodford and his business partner Craig Newman paid themselves £36.5 million.
The financial industry, including the media, granted almost celebrity status to an individual who may only have been there through chance. The victims are the investors persuaded by this hullabaloo to hand over money for Woodford to ‘manage’, only to watch much of it end up in his pocket.