In my interview with Christopher Traulsen, I asked him what he thought of index tracker funds. He did state that he didn’t use them himself but that he thought they were brilliant. In their favour they are usually (but not always) well-diversified and have a low turnover. Christopher explained that high turnover in a fund increases costs trading costs money, for example if you have a large fund it takes time to move money between investments so you have opportunity costs in addition to costs of buying and selling.
One of the problems that Christopher highlighted with index trackers in the UK is that many of the charge far too much. He said that fees of 0.8%-1% are a lot to charge for something that isn’t rocket science â€“ you just buy the index. He sees the introduction of exchange traded funds in the UK (on whichÂ he has written an article) are a good move -Â they have previously been limited in the UK market by rules on stamp duty. This was caveated with the explanation that since they are traded like a company there are broker fees and so are more suitable for lump sum investment that pound cost averaging. The broker fees are also fixed so the larger the amount that you want to invest the smaller the impact the broker’s fees will have on your investment.
Another general problem with index tracking that Christopher pointed out is that they are not well-diversified if the index they are tracking is well diversified. For example the FTSE 100 index is not well-diversified as the FTSE 100 is dominated by the banking and financial sector. Also many single country indices have this problem â€“ they are more likely to be dominated by a handful of banking and telecoms companies which isn’t much of a diversification from the FTSE 100 for example.
As I said before Christopher stated that he uses all actively managed funds, but he did say thatÂ he understood that choosing good fund managers is difficult especially for the uninitiated. In the recent markets only a handful of fund managers in the UK All Companies sector have managed to beat the FTSE 250 index, or a weighted combination of the FTSE 250 and FTSE 100.
The biggest trend in the market of recent times has been the relative under-performance of the large cap companies compared to the small to mid cap companies. Christopher explained to me that normally what is expected is that larger companies will trade at a premium (measured by the P/E ratio) because amongst other reasons they have more liquidity. However globally in the last few years this has not been the case, smaller and medium sized companies have been doing better. He feels that many fund managers have been doing well because they have been riding on the coat-tails of this rise in small to mid caps and that they may not have a good strategy in place for when this comes to an end.
This highlighted another feature of investment culture. Investors chase past performance and this is a poor guide to future returns. Christopher explained that on the Morningstar.com (US) website you can see the investor return for funds. This is a measure of how well the investors did in the fund â€“ taking into account when they bought and sold. He said that often investor return is lower than the fund return. For example looking at technology funds â€“ some have shown an annualised return of 10% for the fund, yet because investors piled in in 200 when the fund was at its peak, they can actually have a negative investor return.
I liked this investor return feature and asked Christopher whether there were any plans to introduce it to Morningstar.co.uk. He said that was commercially sensitive and that there is an underlying problem in the UK in accessing good monthly net assets data which is necessary to calculate the investor return, but they are working on it.
- interview part 1: comparing the UK and US
- interview part 4: lessons learned
- don’t look for better than average returns