- Building on the ‘Basics of SIPP investing’ in Part 1
- How to choose an effective passive investment strategy
- FTSE All-World Index has produced 12.01% annual returns since 2014
- Sample fund of funds produced 10% annual returns since 2014
- Consider tapping directly into the market via an ETF, for better returns
While you’re settling down to a nice glass of whiskey (if you’re partial to that), or perhaps a bit of egg nog in preparation for New Years’ 2020, why not fine tune your investing strategy? If you followed our SIPP 101 post here, then you now understand the basics and perhaps want to find the right approach to take for your investments.
Sadly, this is my idea of a good time! So here’s what I have done for you. I have compared a random ‘fund of funds’ found on the internet to its own internal benchmark and to a simple ETF that you can buy outright on the open market.
The conclusion? The sample fund has under-performed its benchmark.
Let’s construct a simple investment plan that is comprised of just ONE ETF that tracks that benchmark. Better still, that one ETF has been out-performing not just this portfolio, but the vast majority of active portfolios for the last 15 years.
Why is this important? An analogy…
By way of a simple analogy: imagine I am standing up on stage and you (my audience) are in the crowd. I invite one of you up onto stage to stand next to me. What if I told you to copy exactly what I do in front of you? So if I jump, you jump. If I wiggle my nose and roll my eyes, you do the same.
What if I ask somebody at the back of the room and in the middle of the room to copy me too? Who is going to copy my moves the best over time?
Consider this: you have an hour to have a go at it and the best person by the end of the hour wins.
Anybody out there who thinks the guy at the back of the room would win?
The room is a metaphor for the stock market. Myself and my actions are the “one true market” which is the second-by-second and day-by-day changes in actual asset prices. The rest of the crowd are the market participants: some are very close to the action, some are very far away and have a lot of financial advisors, fee earners and consultants between them and the market.
The Approach – Fund of Funds vs Passive ETF
I aim to show you the difference between a ‘fund of funds’ and a single passive investment instrument that closely matches the index. Remember 83% of the stock market for individual investors is still accessed through active funds, including most pensions.
The funds of funds are – at best, following my analogy above – around the middle of the room. Some are way at the back.
The passive ETF is very close to the front if not right on the stage next to me.
Let’s take a look at the fund of funds first.
Randomly Selected – Fund of Funds
|Name of Fund||Weighting||Category||Benchmark||Fees||Dividend|
|Merian Global Equity Fund||18.8||Global equity||MSCI World Index||1.00%||0.80%|
|Capital Gearing IT||12.2||Flexible investment||UK Retail Price||0.90%||0.80%|
|F&C IT||20.4||Global equity||FTSE All World TR GBP||0.57%||1.50%|
|Fidelity Emerging Markets||10.1||Emerging Market||MSCI EM NR USD||1.08%||0%|
|LF Lindsell Train UK Equity||10||UK equity||FTSE All Share TR GBP||0.65%||1.80%|
|Mercantile IT||12.9||UK All companies||FTSE All Share Ex 100 Ex Invt Trust TR GBP||0.47%||2.50%|
|Schroder Asian Total Return IT||15.6||Asia Pacific||MSCI AC Asia Pac Ex JPN GR USD||0.87%||1.80%|
The Fund of Fund was selected at random. This looks and feels like hundreds of offerings out there: MoneyWeek, Investors Chronicle, and Share Magazine all run regular articles that centre around advertising well-constructed investment portfolios that are comprised of tantalizing looking funds.
The key difference is this: they are not low-cost, passive funds, but rather, higher cost active funds where you pay a fund manager to make investment decisions for you. His office, high salary, and costs of trading are all funded by you!
The challenge is that the people who publish these approaches tend to move the goalposts. The funds change over time, holdings get swapped in regularly, so you need to keep buying the magazines and following the site in order to keep up.
Furthermore very few of these ‘Funds of funds’ significantly outperform their benchmarks over long periods of time. As a matter of fact this set of funds isn’t too bad:
|1 Year Performance of this Fund of Funds||13%|
|3 Year Performance of this Fund of Funds||9.57%|
|5 Year Performance of this Fund of Funds||10.08%|
|Performance of this Fund of Funds / Inception||9.57%|
The cost of ownership is 0.78% per year in fees. It has risen 13% YTD and has managed a respectable 9.57% per year return. That being said the FTSE All-World and also the MSCI World Index has risen over 20%. Not a great return if you ask me relative to these benchmarks!
FTSE All-World Index – the Passive ETF
What is interesting about the ‘fund of funds’ is that my passive ETF is one of its two benchmarks! The FTSE All Share is the benchmark for the UK based holdings, and the MSCI World Index (and FTSE All World) is the benchmark for the global equity holdings.
It’s always useful to compare how investments do against their benchmarks. After all, if they underperform the benchmark funds, why not consider using a very inexpensive passive ETF to invest in the underlying index instead?
As it happens, that’s exactly what you find here. Take for example the Vanguard All-World UCITS ETF (GBP). This ETF does an excellent job tracking the FTSE All World index and it has performed strongly over the 1-year, 3-year and 5-year time horizons.
|1 Year Performance of this Fund of Funds||18.4%|
|3 Year Performance of this Fund of Funds||9.28%|
|5 Year Performance of this Fund of Funds||12.01%|
|Performance of this Fund of Funds / Inception||12.01%|
The passive ETF – in the form of the Vanguard All-World UCITS ETF – has outperformed the ‘fund of funds’ by quite a margin.
Remember especially if you plan to open a SIPP account and invest like a pension, the ETF that you choose is going to be very important. If it is under-performing now how confident are you that it will out-perform in the future?
There is a caution here regarding the US equity market. US equities form 55% of the Vanguard All-World ETF – and US shares have seen above-average market returns over the past ten years. As a result the discerning investor would expect there to be a period of below-average market returns over the next ten years.
That isn’t a deal-breaker, though. To prepare for this eventuality, in the absence of a crystal ball, or the gift of foresight; you need to figure out what your risk tolerance is and invest accordingly.
Have a look here to find out what your maximum drawdown amount is and to determine how much of your hard earned cash you plan to invest in the market.
It boils down to better fees and performance
At the end of the day it always comes down to all-in costs and long term performance.
- 92-95% of Active funds under-perform over 15-year time periods
- You can reduce those fees and keep the money for yourself
Having been at this for over a decade, I can say this much: it rarely makes sense to split your money between several active funds with fees above 0.5%. They are highly likely to under-perform the market in the future, because 92-95% of all active funds have under-performed over 15-year time frames.
If you want proof here’s why: the majority of private investors will have portfolios of less than £150,000. According to our sample ‘fund of funds’ above you’ll pay 0.78% per year in fees to the fund managers. However, you’ll also pay fees to the SIPP or ISA provider for giving you access to the market in the first place. Even provided that you go with AJ Bell, one of the best brokerage firms out there, you’ll still pay 0.25% per year as an annual maintenance fee. And in order to invest you’ll do at least 1 trade per month.
That adds up to 1.19% per year if you have £75k and trade once per month for your ‘fund of funds’ (using AJ Bell)
If you went with the passive alternative suggested above – the Vanguard All World UCITS ETF – then your total fees are 0.6% per year for a £75k portfolio trading once per month.
However more to the point, it’s not just 0.59% in fees that you save per year. The FTSE All World UCITS ETF has been out-performing the ‘fund of funds’ by 2.44% per year. That’s a big margin. While the ‘fund of funds’ has been charging you for trading, for investment management and consulting fees, the passive index has been more or less automatically investing for you. The passive ETF just mindlessly owns shares that track the index.
In other words the difference in performance is a staggering 2.44% per year when you factor in fees and year-over-year performance, which works out to £1,830 more per year in your account by using the passive ETF!
There are of course risks with following the Vanguard All-World index (or MSCI World Index). One of those is the high weighting (55%) to the US Stock Market. If there was a downturn in US stocks then this index would feel the brunt of it.
That being said, over the past ten years the funds have matched the performance of their indexes. The frustrating thing about ‘funds of funds’ is that they tend to under-perform when the market is rising and they do not compensate you by outperforming when markets fall.
Whatever investment strategy you choose to go with, what you’ve hopefully learned is two lessons:
- Use data, numbers and fact to analyse the performance of any investments you choose to make. Oftentimes active funds will under-perform their benchmarks over 5- and 10- year periods
- Consider investing in the underlying benchmark itself, like the FTSE All-World Index, MSCI World Index, S&P 500 or the FTSE All-Share index. When markets rise 20% (like they did in 2019) you’ll experience far more of the upside, instead of the money going to your fund manager’s Ferrari and his children’s private education.
As always make sure you do your own research and choose funds that match your risk tolerance and exposure to the market.