Managed Funds are a way to own shares without having to select the individual shares yourself. It is a way to pool all investors in a group and share the benefits together. You buy units in the fund from the fund manager and sell these units back in the future to this fund manager.
This industry has exploded with many to choose from but for the last 40 years most managed funds have not beaten the market average. The major reasons for the underperformance are index tracking, the management fees and high operating costs.
Below are some of the reasons the reasons why managed funds may be inferior to direct share investing:
Lower Returns: A study conducted from the SPIVA score card identified some interesting figures: 67.76 % of Australian Equity general funds underperformed against the S &P/ASX 200 on a 3 year basis. 61.86% of Australian Equity Mid and small cap funds underperformed against the S&P/ ASX mid-small index on a 3 year basis. 92.86% of all Australian-Equity A-REIT funds underperformed against the S&P/ASX 200 A-REIT Index on a 3 year basis.
Fees: There may be an upfront entry fee or an exit fee. Some funds may also have a trailing commission fee to financial planners at 0.5% per annum. All funds charge a Management Expense Ratio (MER) which is about 0.7 per cent to 2 percent with active managers charging a higher fee. Managed funds also charge performance fees. This is the fee which the fund manager charges when their returns are over the benchmarked index. These fees are a whopping 10% to 20% of the outperformance.
Redemption issues: If there is a hoard of investors wanting to withdraw their money from the managed funds, the fund manager may need to sell their liquid assets to keep up with all the withdrawals. To prevent this from happening, they may choose to freeze any redemptions. This happened recently to the UK property funds during Brexit. These funds halted withdrawals as too many people were taking money out simultaneously.
Taxation issues: With direct shares, you can use your franking credits from your dividends to reduce your tax payable. In a managed fund, there are unknown tax issues as funds do not need to disclose their potential tax liabilities. Units which you buy may inherit tax liabilities on gains which you did not benefit from. Also you cannot use the capital losses in a managed fund to offset capital losses you have outside of the fund.
Over diversification: The number of stocks required for an optimal diversified portfolio is 30. In these managed funds, the amount of stocks they hold can be anywhere between 30 – 100. Diversification can reduce risk but holding more than 30 stocks does not further reduce your risk, it rather often leads to bad returns.
Flexibility: Another issue with having managed funds over direct shares is the flexibility to liquidate stocks when needed. Big fund managers such as Platinum Asset Management manage about A$23 billion. They hold large positions in stocks so if a stock goes pear shaped, they may find it difficult to liquidate all their positions. As an individual investor with a smaller holding, it would be easier to sell your position with a simple call to your stock broker. Fund managers may also have mandates which require them to hold a certain percentage of cash in their funds. As an individual investor, you choose how much cash you want to hold in a trading account. In a bear market, you may want to hold a significant portion or the whole portfolio in cash. This choice would not be available in a managed fund.
So I believe that direct shares have many advantages. However, you need to know how to manage your share portfolio. You need a system, a strategy that allows you to cut losses short, let profits run and diversify sufficiently without over diversifying. On top of that you need the discipline to stick to your rules and trade at your numbers. This is not easy and does not come natural. As such you have to educate yourself through reading the books of the Masters and developing your own investment strategy. This will take a fair amount of time and effort but can be very rewarding in the end. Alternatively, you can short cut your learning curve and use the experience of market educators and professionals to your advantage and learn through investment education courses. Check out http://tradingpro.com.au/education/ on how we approach investing. Maybe our approach makes sense to you and you find it worthwhile exploring our system further with a no risk 30 day money back guarantee.