What's better? - Funds or Shares?

Tuesday, 29th January 2019 07:22 - by Ranjeet Singh

There has been a lot of talk recently about funds and their usefulness in a bear market. After all, when things are slowing down and the stock market is falling in value, the idea that a fund will somehow do better than an individual share is quite frankly a nonsensical argument.

In most cases a fund is simply a type of Collective Investment Scheme (CIS) which means that it is a collection of individual shares. This means that it is more aligned to a sector or perhaps an entire index rather than any single share, which in turn means that it is less reactive to market changes. In other words, it just means that investors who buy into a broad-based fund will probably just lose their money a little more slowly than somebody who likes direct share holdings. But they still lose.

And whilst I may sometimes appear to cut a slightly outspoken figure when it comes to voicing my opinion on the financial markets, you will be glad to know that I am not alone when it comes to the controversy about the usefulness of funds. Indeed, one highly debated topic at the moment within the professional investment community is the idea that certain ‘fund lists’ are actually of any use.

For example, you would have probably heard about titles such as ‘The Top 50 Funds’ or ‘The Top 25 ETFs’ or whatever it may be. In fact, the lists of ‘best this’ or ‘best that’ seem to be never-ending, and for good reason. You see, we are all so wary of scams in the market place, that we are constantly looking for affirmation from other users to justify our buying decisions.

It explains why reviews are so popular, and it’s why ‘Which’ magazine is so successful – because it helps us to make more informed decisions.  

However, there is also a problem, which is that retail investors can now be more easily led to believe that something is great just because it says so on the tin.

The ‘Top’ Funds. Really?

It’s because of the extra revenue and profits that come with a top list rating, that incentivises the majority of funds to always do their best to try and make it onto these so-called prestigious lists. If they can get onto that list, their star shines a little brighter than the others, their marketing teams have a little more ammunition when promoting the fund, and the fund managers involved end up accumulating a little more money in their already generous bank accounts. Who wouldn’t want to be on a top list, right?

The problem is that these lists are not as credible as you might think and I believe that it should all be taken with a very large pinch of salt. Unless there is an official, regulated list of top funds, I wouldn’t be listening to individual wealth management or brokerage firms that are intent on creating their own lists unless you can really see the criteria behind their decisions.

That’s not to say that they are doing anything wrong or illegal, of course they would not be so stupid. But there is a question mark over how truly independent a list can be. For example, did you know that Hargreaves Lansdowne (HL) generally only opens its ‘top list’ to those funds that agree to discount their fees. It’s part of the HL marketing campaign i.e. “buy through HL and secure a discount”. Take a look at their ‘Wealth 50’ fund and you can see how many of the genuine top performing funds are not included in that list.

It does also raise the rather unsettling thought that there may be a large number of very successful funds which don’t feature in the so-called top list simply because they refused to offer any form of discount.

It’s also quite probable that the funds which refuse to give away discounts are the very ones that can afford not to i.e. the strongest funds will probably refuse to negotiate a discount because they know that they have a superior product offering (i.e. a better performing fund). The weaker funds on the other hand which are likely to be more desperate to work with a larger organisation to promote their fund, are more likely to accept a fee reduction. Therefore, the irony is that the top fund list could actually end up to be a collection of the weakest funds in the market.

Hopefully you can see the dilemma. In my opinion there should be greater regulation around any list purports to be the ‘best’ and an authoritative body to control this, so that we can all see which funds really are the top performers. There would be nowhere to hide and it would be a free and fair playing field for all concerned. It’s like the Premiership – we don’t have multiple lists of the best football teams in the country. There is just one and everybody is confident that it’s an accurate list. That promotes confidence.

And it’s not just HL. Take Interactive Investor for example; it recently launched its ‘Super 60 Selection’ but again one must look a little deeper as to how these funds are chosen for this list. How ‘super’ are they really and based on what criteria?

Passive vs Active

There is also the burning question about the possible pros and cons of passive funds against active funds. One half of the investment community believes that active funds are the quickest way for an investor to bleed their share portfolios dry through higher than average fees and higher risk taking in search of above market index returns. They firmly believe that passive funds are the only way forward.

The other half of the investment community states a strong case against passive funds to say that they are little more than glorified index rate trackers and in the long run tend to match the stock market, except they almost always underperform because it has to take off its annual fees. In such cases, they argue (quite convincingly in my opinion) why it would make more sense to just buy an index rate tracker instead.

However, there is a third, lesser known part of the investment community which I belong to which doesn’t quite fit into either of these groups. You see, I don’t see this as a black or white issue. Passive funds can be fantastic for lower risk, longer term diversification investment strategies, particularly in far-away, remote geographical locations where one may not necessarily have a huge amount of investment knowledge in those regions.

Similarly, active funds are brilliant if you can find a fund manager who you can trust and who will, more often than not, beat the stock market index. Even if you have to pay a little extra for his or her services, it’s worth doing if you know that they are going to deliver.

But there is an even better way that beats both in my opinion.

Bespoke Portfolios vs Funds

And so how about a different idea altogether? How about actually making your own fund? At London Stone that’s what we do. We build bespoke investment portfolios for our clients which means that rather than paying a fund manager that you have never met before, to manage a fund that you have no control over, instead you create a fund or portfolio for yourself.

It’s cost-effective, more reactive to the market conditions, and if you do it right, it can be significantly more profitable. Oh, and did I forget to mention that it is a whole lot more fun as well. Of course, as you might expect there is more work involved which is why you need to employ somebody capable to do the leg work and research for you. But when you put it altogether the art of stock selection, mitigating risk and earning above market returns without the shackles of an annual management charge, is something worth fighting for.

And from what I can see investors prefer it. In fact, the primary reason that most people invest in funds is because they don’t have the time or knowledge to feel confident that they can do a good enough job themselves. It’s not because they prefer funds just for the sake of it. It’s sad really to think that independent firms that use traditional forms of investment are in many ways fast becoming a dying breed whilst the market becomes awash with standardised funds.

I don’t think that’s good for anybody, not least the end investor. Whatever happened to creativity and innovation? The truth is that there are countless opportunities in the market place every single day and you don’t need to pick all of them, in fact you don’t even need to pick a fraction of them.

You only need a handful of good ideas every year based on some simple, good house-rules of investing. If you still don’t know what I mean take a look at how your funds performed last year and you will see how most funds simply mirror the general market conditions. There is no rocket science to what the majority of average fund managers do and despite the glitzy headlines, the posh names, and the endless ‘top lists’, they are, in the main part, all much of a muchness.

Start to think differently today and you may just see some surprisingly new results tomorrow.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.