Morning Line: Is your fund manager really necessary?

Hands up all those fund managers who sold their holding of BP before the share price collapsed?  One of the, largely unremarked, casualties of the BP Deepwater Horizon disaster has been professional fund management.

For the private investor selling BP shares as soon as the extent of the oil spill became apparent was virtually a no-brainer.  Most investors, whether individuals or funds, hold BP for the handsome dividend it paid.  Deepwater Horizon exploded on April 16^th and by the end of the month it had become apparent that BP management had been less than honest about the full extent of the oil spill and that the clean up costs would run into billions, putting the dividend in jeopardy.  The share price started to slide from its high of 651p and by the end of April stood at 584p.  Time to get out.

Why hang on and wait to see if the dividend was cancelled when you could sell and avoid a nasty fall in the share price?  Not only that, but it was perfectly possible to switch into Royal Dutch Shell or Total if you wanted to retain your exposure to oil stocks – both of which were paying dividends of around 5% to 6%.

I happened to be in Florida in April and as I wrote in Citywire, on 28^th April I sold my entire holding of BP shares, a major part of my portfolio. 

But professional fund managers seem to have largely hung onto their BP holdings which make up a substantial proportion of most UK All Companies funds and many other UK invested funds, not least of all because whether they are active or passive fund managers, they keep a substantial proportion of BP in their portfolio in order to ensure that they don’t under-perform their relevant indices.  Even active fund managers track the index with as much as 75% of their portfolio – although few will admit it. 

Some fund managers have claimed that the BP debacle highlights the virtues of ‘active’ fund management. But the figures don’t really bear this out (at least to the extent that you should follow short term numbers).  Citywire’s performance figures show that over the past three months, which covers the period since the BP explosion, the average ‘active’ fund manager showed a 1% return and 93 out of 137 funds showed a positive return.  This compares with the average All Companies sector (which contains the tracker funds) where the average fund showed a return of 0.4% over the three month period and 156 out of 310 funds showed a positive return.  The 0.6% difference is likely to be lost in the higher charges for so-called ‘active’ management.

Since April the BP share price has almost halved, falling from its high of 651p to today’s 364p but even after this dramatic fall it still comprises 5% of the FTSE100 index.  Unless ‘active’ fund managers had sold back in April, this fall will have dragged down their performance and from the Citywire figures it doesn’t look as though many used their commonsense and got out.  This is because they are locked into tracking the index with a proportion of their fund – even if they don’t admit it.  Even worse, to rebalance their fund many will be selling BP now at 40% below its previous high – just when speculative investors are buying BP (although it might be better to wait until BP has finally managed to cap the oil spill).

Mutual fund investors are paying a high price to see the value of their investments fall.  Active fund management costs more than simply buying a tracker fund or an ETF.  But even if you ignore the effects of the BP disaster, at any time only a quarter to one third of fund managers – whether active or passive – outperform their relevant index, and it is rarely the same 25% to 30% each year.  During 2008, 55% of actively managed funds underperformed the FTSE All Share. In the previous three years this was 69% and over five years it was 72% - not very impressive.   (Which is why Citywire’s ranking of fund managers based on consistency is so important.)

But tracker funds have their limitations too – not least because of the heavy concentrations of a few companies which this produces and the inevitable risks this involves.  A fund which tracks the FTSE100 would have almost 50% of its holdings in just 11 companies and would be heavily weighted towards the financial sector and mining.  Two companies alone, HSBC and Shell, comprise 17% of the FTSE 100 and BP another 5%.  

So is your fund manager really necessary?   The answer is a qualified yes.  But you must take an interest and be prepared to act.  When the BP disaster occurred it would have made sense to talk to your IFA and find out what proportion of any funds you held were invested in BP and if necessary, sell that fund.  It would help too if fund managers were more willing to divulge their investment strategy and individual holdings.