Warren Buffett once famously said: "if you have 2 per cent of your funds being eaten up by fees you're going to have a hard time matching an index fund in my view." All of which begs the question: do fund managers make a difference to the performance of an actively managed fund? And just what is the purpose of a fund manager anyway?
The question may sound impertinent to those with greater knowledge of how to pick and invest in stocks than the financial layman, but it is legitimate. After all, shouldn't retail investors reasonably expect a high proportion of the funds they invest in to at least contain a basket of stocks able to better the market and afford them a degree of security?
Buffett, suffice it to say, knows a thing or two about money and how best to maximise its potential. He has made compound returns of 20.46 per cent per annum for the last 45 years up to 2009, according to fund manager Terry Smith of Britain's Fundsmith.
Smith points out that if you had invested US$1,000 in shares of Buffett's Berkshire Hathaway - founded in 1965 - your investment would have been worth a whopping US$4.3 million by the end of 2009. Even allowing for inflation, that's active appreciation.
But Smith goes on to explain the really interesting part. "If instead of running Berkshire as a company in which he co-invests with you, Buffett had set it up as a hedge fund and charged 2 per cent of the value of the fund as an annual fee, plus 20 per cent of any gains, then of that US$4.3 million, US$4m would belong to him as manager and only US$300,000 to you, the investor," he says. "And this is the result you would get if your hedge fund manager had equalled Warren Buffett's performance. Believe me, he or she won't."
All actively managed funds carry the burden of extra fees. Expenses ratios of 1 to 2 per cent are not uncommon. And if a market only rises 3 per cent per year that still means more than half of your returns are being absorbed by fees.
Rene Buehlmann, global head of investment funds at UBS Wealth Management, agrees that managing a fund is not without its challenges but he also advises investors to take a look at the bigger picture.
"According to Morningstar research, the total average cost for offshore exchange-traded funds (ETFs) is 0.47 per cent versus 1.64 per cent for offshore managed funds," Buehlmann says. "So it is quite legitimate to ask whether the active manager is worth the extra cost."
He says a great deal depends on a fund selection, which should be informed and based on investment fundamentals, research outlook, and time frame. Managed funds are often unsuitable for short-term trading as managers tend to select instruments and undervalued assets that may take time to re-price, he adds. Additionally, index tracking is unavailable for specific investment themes, such as broad-based plays on Asian consumption.
He also says that UBS has funds - including Hong Kong and Asia-Pacific ones - that have outperformed the index by a wide margin. And while you may pay 1.64 per cent for potential alpha or high return compared with 0.47 per cent for an ETF, you are only gaining access to a lower return or market beta.
Angel Wu, regional head for products and solutions (Asia) at ABN AMRO Private Banking, agrees that although it is a time of market volatility coupled with global macroeconomic and policy uncertainty, all is not lost. "If you select a good fund manager, you can outperform the market."
She admits that average Hong Kong equity funds with returns of 6.8 per cent to 7 per cent have trailed MSCI Hong Kong tracker fund returns of 9.7 per cent - but that is also part of the challenge for fund managers. [The tracker fund, listed on the Stock Exchange of Hong Kong, holds a portfolio of shares designed to provide investment results that closely correspond to, or track, the performance of Hong Kong's Hang Seng Index]. She says fund selection takes a lot of processing and that while it is not easy to source good managers they are out there - and they can still find alpha. "But it is difficult in this climate to have actively managed funds."
So, how to choose the right fund manager?
Chi Hao Lee, head of active advisory and investment solutions (North Asia) for Barclays, says the key for investors is to focus on a manager's strategy selection, when making a choice about the right fund manager.
"The key component for successful fund managers is to be able to protect as much as possible against downside risks and shocks," says Chi. "Managers that adopt an actively-managed approach and those who use an element of hedging tend to fare better."
Given the volatile nature of the markets, a buy-and-hold value-based investment strategy and approach may not work as effectively as a more nimble actively-traded fund portfolio. In volatile markets, it is perhaps more important to mitigate your losing positions as much as running up your winners and taking profit, he warns. Such is the reality in cautious markets.
Buehlmann also believes a good fund manager can make a big difference to an investor's portfolio. While fund managers may find it challenging to make a difference, he says, there are many "outperforming" managers. "Hence you need a professional team to help in the fund-selection process."
Buehlmann says too many clients still look only at performance, forgetting the past does not always predict how funds will perform in the future.
He says value comes with taking outperforming funds and pairing them up with solid research and market outlooks. "Ongoing monitoring by our globally-based fund managers is the key to identifying next year's outperformers," says Buehlmann.
Barclays' Chi believes one of the advantages of funds is that the good ones keep up with the latest investment trends - which is a good thing. "Other strategies that have fared well and that Barclays has been favouring include dividend-income-paying funds," he says.
With many companies at record-high cash levels, coupled with depressed equity markets, investors have been enjoying the relative safety of high-dividend yields, Chi adds. He points out that these funds have outperformed the broader markets and that some have been generating year-to-date returns in excess of 13 per cent.
Ideally, the right strategy and manager selection can be blended to provide a more diversified investment approach - but this requires proper due diligence and understanding how a manager works, he says.
Buehlmann also believes in the diversification offered by funds. "Funds are the most efficient way to gain access to a variety of investment themes, asset classes and managers with different skills across regions," he says. "If you have five-to-seven different funds in your core portfolio, you may own up to 1,000 securities that are monitored and researched by experts every day. Your returns should be less volatile while your risk is diversified without losing its flexibility."
Meanwhile Wu says clients are becoming more demanding in terms of needing and wanting more information themselves. However, she welcomes this positive step - in today's climate investors are prepared to be more patient rather than simply pulling the trigger. But Wu still says there is a long way to go to get Asian investors to see the wisdom of diversification. "We spend a lot of effort on educating clients on matters such as asset allocation," she says.
Meantime, anyone found alpha?