Infratil Limited (NZX:IFT)

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Why I Don’t Invest In Managed Funds

Managed funds seem like a great option. They let you invest your money and have a professional manage the investment to ensure peak performance and safe harbor of your cash.

Listed managed funds are typically priced based around their NTA, which is comprised of the value of the stocks they hold. Sounds fair? You get the stocks you pay for and often don’t pay anything up front for anyone to manage it. They also pay dividends that are bigger than the dividends paid by the stocks they manage.

But it’s not all roses, and here’s why. Fund managers (a term I will use generally in this article to refer to any company managing a fund, be it an ETF, Listed Fund, Managed Fund, etc.) take a cut of any increase to the value of the stocks they manage. This is typically performance related, which seems fair because they are taking a slice of the value they add. However, the reality is that during a bull market most stocks go up, and the fund manager will take a cut of this unearned success. They’re taking a cut of market sentiment and inflation rather than company performance, which is a major contributing factor to the success of any fund. They also get paid when the stocks under perform, which seems hypocritical. Of course, the counter to this argument is in the case of funds that are actively traded, whereby you’re paying for the fund managers skill of trading on market sentiment (though I would question the return available on the small markets in Australasia – See my comments below on agility).

It seems to me as though the performance related fees are not to incentivize companies offering management of funds, rather they are an excuse to charge more, since the disincentive of not having any customers due to poor performance is already there, and such companies make enough to pay bonuses to the people trading the stocks anyway.

Next is the matter of the dividends that are too good to be true. Listed funds typically pay dividends that are in the region of 5% to 10%, which is well above the dividends paid by the stocks in the fund (Examples of this are Marlin Global Limited [NZX:MLN] and Kingfish limited [NZX:KFL]). They manage to do this by selling off stock as it increases in value. Therefore the stock you own in the fund (while it’s increasing in value) is ever diminishing in terms of the percentage of the companies owned. This money is used to pay dividends (which make the value of the fund deceptive) and pay themselves. Remember that even when the fund is under-performing, it’s getting further eroded by fund manager fees – This is the case for all types of funds who do not derive their payment directly and solely from you as a fee, because fund managers have to get paid to cover their salaries, admin staff, rent, etc.

Finally, due to the large volume of funds managed, fund managers cannot act in an agile way to avert damage from black swan events, downturns or under-performance of stocks. For example it takes a long time to sell off millions of dollars of stock compared to a small shareholder who can pivot much more easily. Consequently, you will end up paying for this, as your loss is averaged across the sale of the whole big transaction.

In summary, it’s never a good idea to put someone else in charge of your money, unless perhaps if you don’t know what you’re doing or if there is some other benefit like tax or employee incentive schemes, such as those that come with Kiwisaver or pension schemes. You may also consider a managed fund, ETF or similar if it’s the only way to gain access to a particular stock that you otherwise wouldn’t be able to buy into, such as Infratil‘s interests in Wellington Airport, or if the fund is trading market sentiment and they’re better at it than you are (an example of a fund that trades market sentiment is BetaShares Australian Equities Bear Hedge Fund [ASX:BEA]).