When are investors going to wake up to the relentless rules of humble arithmetic and recognise that costs matter when investing? Simple arithmetic dictates that the generation of profits by investment companies requires charging fees above the basic cost of providing investment services. As investors we can only guarantee what we will pay in cost and fees for services given to us, not the return on capital. And as data published on fund managers by the leading research company Morning Star shows, yesterday’s high-flyers will be tomorrow’s also-rans. Many investors will be anxious as stock markets globally have given back gains made during last year and in the case of speculative punts into crypto-currencies, dramatically so.
It is a given that the majority of active fund managers will fail to beat the market index that they use as a benchmark to measure their success. Following a report by Standard and Poor’s US rating agency and accredited academia, they will do so by the same amount as their fees and costs. To hire the select few that will beat the market, is like ‘looking for a needle in a haystack’. Much more sensible to just buy the haystack.
Successful investors understand that the more we keep of our own capital, the more we make over time. Sensible investors recognise that their interests are seldom aligned with the manager of an investment fund whose priority is to achieve the best return for the shareholder of the management company at the expense of the investor. In this conflict between motive for profit and fiduciary responsibility to the investor, profit will always win.
However there are not-for-profit (NFP) US Mutual Fund companies that align investors’ interests with their own. The Vanguard Investment Management Company, founded in the US in 1976 by John Bogle, is owned by and run for the investors. This investment company specialises in offering funds that mirror the return made by the market, by constructing an index to replicate the companies held in a given market sector in the proportion that they are held by size of capitalisation. An NFP approach allows the company to offer their index funds at a cost on average 70% below those of other management groups in the industry.
Another NFP is The Teachers Insurance Annuity Association (TIAA) and the College Retirement Equities Fund (CREF), another NFP founded by Andrew Carnegie to improve the income of retired college and university professors who in previous decades have seen their standard of living decline substantially.
When evaluating an NFP investment manager, investors have the comfort of knowing that their interests are aligned with those of the management company. For-profit managers’ interests are not aligned with the investor. Investors face a daunting task of making difficult decisions with inadequate information. NFP managers enjoy a single-minded focus on discharging a fiduciary responsibility to investors. When the obligation of generating profits disappears, so does the conflict of interests allowing investors to take advantage of ‘the humble arithmetic’.
Jeremy Blatch TEP
This article was also published in the online and print editions of the Sur in English