Why 'low cost equity funds' is a flawed concept

Professional Adviser speaks to M&G managing director and global head of retail sales, Jonathan Willcocks, about his views on low cost funds and charging levels.

What is M&G’s opinion on 
low-cost active funds?

I am not a believer in the low-cost options of index plus one funds at all. I think it is a getout clause for managers. Some groups are doing it to ensure they occupy a certain space in the market place post-RDR but I think it is a flawed business decision.

We fundamentally believe in our ability to generate alpha and our whole business is set up to do this. Why would I constrain our fund managers when I think they can generate index plus 2%, 3%, 4% or higher depending on their strategy?

These groups are assuming they can generate index plus one but presumably this is in a smoothed environment as the entry point of every client is different. To generate index plus one you have to take risk and have the ability to outperform but what if there is tremendous performance in the first month and you have reached index plus one already?

The first investors who bought it are happy but what about the people at the end of the run? I think the index plus one aim will be quite difficult to achieve in a smoothed way for each client.

Why would you want these funds as an investor?

If advisers are worried about RDR and trying to cap the overall charges within a certain boundary there could be a driver to use low cost funds to get the overall TER down.

The choice is you could pick up a low cost active fund trying to generate index plus one and pay 45 basis points (bps) AMC but you only get index plus one if all goes well.

Or, you could put half a portfolio into a tracker at 30bps and the other half in 75bps funds which have a sustained track record of delivering alpha.

You would only need the active part to deliver index plus two or more and you are better off than being stuck in index plus one.

You would have the upside and a bit more downside buying an active fund but I think your risk reward balance is skewed to the upside if you pick the right fund manager.