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    • Voyager2002
    • By Voyager2002 15th Sep 17, 3:32 PM
    • 11,669Posts
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    Voyager2002
    Active management and value for money?
    • #1
    • 15th Sep 17, 3:32 PM
    Active management and value for money? 15th Sep 17 at 3:32 PM
    Suppose (for the sake of argument) that you want an actively-managed fund for a particular sector...

    How would you establish whether the performance of the fund offered good value for money in relation to the management charge?

    At first I thought that it would be a question of comparing the Alpha value with the AMC, but many investments that appear to have done well actually have negative Alphas! And there is a more fundamental point that worries me: presumably a good active manager would pick certain stocks whose performance would be very different from that of the benchmark index. That would mean that the figure for R squared would be low: however, I have read that the method for calculating Alpha is only valid when R squared is relatively large! So is this kind of approach ever going to work?

    The issue arises because I have inherited some investments with Saint James' Place. The up-front fees are sunk costs, and the investments are so old that there would now be no fee to cash them in (and possibly reinvest in trackers or other funds). The annual management fees seem rather high, but the performance looks good, so it is hard to know what to do...
Page 1
    • Money Help
    • By Money Help 16th Sep 17, 7:45 AM
    • 34 Posts
    • 15 Thanks
    Money Help
    • #2
    • 16th Sep 17, 7:45 AM
    • #2
    • 16th Sep 17, 7:45 AM
    Investing is a zero sum game. For every buyer there is a seller. Once you factor in charges the probability of beating the market is against you. That's not to say active managers can't do it but to do it consistently is very difficult. You need to decide your investment objective and how much risk you are prepared to take. Around 80% of investment returns are driven by asset class choice rather than fund manager influence.
    • TheTracker
    • By TheTracker 16th Sep 17, 8:24 AM
    • 1,125 Posts
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    TheTracker
    • #3
    • 16th Sep 17, 8:24 AM
    • #3
    • 16th Sep 17, 8:24 AM
    Overall, of course, active management loses to passive. Returns are the same, minus fees, and the fees at c1% are significant vs average returns.

    And of course, like in any field, active managers have varying skill.

    As an aside, it's a common misconception that passive advocates consider fund managers to have no skill. Far from it, we just hang on to their collective coat tails without paying their fees. In aggregate we consider they have skill.

    But finding the managers with skill is a signal vs noise problem. The narrow band of outlier ability (perhaps an alpha of a few percent?) is drowned by natural volatility swings many times that size. Over decades and at the end of the career the filter shows who _might_ have had alpha.

    As the commenter above notes, that's not the end of the story. One must adjust for beta. Different asset classes have historically displayed different returns regularly and long term, and economic and behavioural theories support these characteristics. We must account for the fact Buffet is a value investor, for instance. Or that one fund is more tilted to small companies.

    So now you have to adjust for signal vs noise vs beta to see what ability the active manager has and whether it was worth the fee. If that's possible, one must wonder why some breed of active manager hasn't been popularised that beta on other skillful active managers it can spot. Me? I'll hang on to the coattails for a lazy free ride.

    Given all this, the chance that some dude in his armchair perusing Trustnet on a Sunday afternoon, or even some brown cardiganned financial advisor who spends 40 hours a week reading tea leaves, can beat a passive portfolio through ability not chance, is frankly ludicrous.
    Last edited by TheTracker; 16-09-2017 at 8:28 AM.
    • Linton
    • By Linton 16th Sep 17, 9:33 AM
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    Linton
    • #4
    • 16th Sep 17, 9:33 AM
    • #4
    • 16th Sep 17, 9:33 AM
    To answer the OPs question, the alpha beta model is a simplistic assumption. Many active funds have an asset allocation that does not correspond to a particular indexed market and so the premise that there is a meaningful constant alpha and beta becomes unrealistic. Over some time periods alpha could be negative if the active fund rose in a falling market or vice versa.

    And to further answer both the OP and the index cultists who believe that true salvation is only possible if you follow their Way......

    What is most important in constructing a portfolio isnt the individual funds you choose but rather the overall composition of the portfolio in terms of high level asset type, industry sector, geography, company size, investment style etc etc to meet your performance and risk requirements. So dont look for the best performing funds (though it makes sense to screen out bad ones), look for funds that work together to meet your requirements either active or passive. The advantage of active funds is that there is a much wider choice particularly of investment style and company size which helps you put together a well diversified portfolio. The disadvantage is higher charges. However a higher charge of a fraction of 1% is much less damaging than a poor overall portfolio.
    Last edited by Linton; 16-09-2017 at 9:37 AM.
    • kidmugsy
    • By kidmugsy 16th Sep 17, 12:32 PM
    • 9,853 Posts
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    kidmugsy
    • #5
    • 16th Sep 17, 12:32 PM
    • #5
    • 16th Sep 17, 12:32 PM
    How would you establish whether the performance of the fund offered good value for money in relation to the management charge?
    Originally posted by Voyager2002
    The question is in the wrong tense. The best you can do is to discover how well it did in the past.
    • MPN
    • By MPN 16th Sep 17, 2:01 PM
    • 236 Posts
    • 79 Thanks
    MPN
    • #6
    • 16th Sep 17, 2:01 PM
    • #6
    • 16th Sep 17, 2:01 PM
    St. James's Place (SJP) do have some very good funds (SJP Global, North American, Greater European & International Equity to name a few), therefore some investors will be happy to pay the high fees (around 1.75%) as long as overall they are achieving good performance/results for their clients.
    • bigadaj
    • By bigadaj 16th Sep 17, 7:13 PM
    • 10,736 Posts
    • 7,025 Thanks
    bigadaj
    • #7
    • 16th Sep 17, 7:13 PM
    • #7
    • 16th Sep 17, 7:13 PM
    St. James's Place (SJP) do have some very good funds (SJP Global, North American, Greater European & International Equity to name a few), therefore some investors will be happy to pay the high fees (around 1.75%) as long as overall they are achieving good performance/results for their clients.
    Originally posted by MPN
    The performance isn't too bad but it isn't stellar, and there's the eye watering 5% initial fee that they appear to still charge on many of their products high is totally anachronistic.

    It's still a very poor option for virtually everyone.
    • ColdIron
    • By ColdIron 16th Sep 17, 7:45 PM
    • 3,582 Posts
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    ColdIron
    • #8
    • 16th Sep 17, 7:45 PM
    • #8
    • 16th Sep 17, 7:45 PM
    St. James's Place (SJP) do have some very good funds
    Originally posted by MPN
    Nothing wrong with SJP funds, they are generally run by well known fund managers. The issue is that you can access the almost identical funds they manage as their day job for considerably less cost. Heinz Baked Beans at Harrods prices
    • grey gym sock
    • By grey gym sock 16th Sep 17, 9:14 PM
    • 4,131 Posts
    • 3,643 Thanks
    grey gym sock
    • #9
    • 16th Sep 17, 9:14 PM
    • #9
    • 16th Sep 17, 9:14 PM
    To answer the OPs question, the alpha beta model is a simplistic assumption.
    Originally posted by Linton
    there are more complex models you could use. in each, the idea is that the alpha is just the unexplained part of the fund's performance. so the simplest model just has exposure to the market (beta), and whatever is left over is called alpha.

    but a more complex model might posit that a fund has various exposures to 3 factors: the market (beta), the extra return from small-cap shares compared to big-cap (the "size" factor), and the extra return which you might expect (on average) from holding financially/operationally distressed companies (the "value" factor. and then whatever part of the return is not explained by those 3 factors is called alpha. and that will usually give a different number to the simplest model.

    and then you might use a 4- or 5-factor model instead. which would probably give different answers again.

    so which is the right model?

    well, who knows ...?

    but if you may not be using the right model, you can't have much confidence that the manager really has alpha. for instance, perhaps they just bought a lot of small caps, and small caps did well.

    in any case, the main point isn't to select mangers with high alpha. partly because that's difficult to do with any confidence - alpha is often fleeting. but also because what more important is what kind of portfolio you have, in terms of big-cap versus small-cap, risk, etc.

    you can express that question in the way linton has done. or you can ask: how much exposure do you want to the small factor, the value factor, etc? and arguably, those are 2 different approaches to the same question.

    the simplest, cap-weighted, big-cap-dominated tracker funds will only give you exposure to the market factor. if you want exposure to other factors (and you don't have to - there is an argument for keeping it simple), then you are either looking at active funds, or so-called "smart beta", or at relatively simple cap-weighted trackers which exclude the biggest companies (e.g. FTSE250 trackers).
    • Voyager2002
    • By Voyager2002 16th Sep 17, 10:48 PM
    • 11,669 Posts
    • 7,908 Thanks
    Voyager2002
    Thank you for all these thought-provoking responses.
    • MonroeM
    • By MonroeM 16th Sep 17, 11:14 PM
    • 114 Posts
    • 32 Thanks
    MonroeM
    Nothing wrong with SJP funds, they are generally run by well known fund managers. The issue is that you can access the almost identical funds they manage as their day job for considerably less cost. Heinz Baked Beans at Harrods prices
    Originally posted by ColdIron
    Absolutely, I totally agree that you can find more or less identical funds without the high costs.
    Last edited by MonroeM; 17-09-2017 at 10:40 AM.
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