Warren Buffett fund illustrates 'rip off' management charges

Warren Buffett fund illustrates 'rip off' management charges


By Ian Cowie Your Money
Last updated: September 29th, 2010

If you think the row about fund management charges is a tedious technicality then prepare for a rude awakening. Terry Smith is the latest outspoken multi-millionaire to lob a hand grenade into this debate which will shake the City to its foundations and could bring several institutions crashing down.

He claims investors are left with less than a tenth of the total returns some fund managers receive – and uses Warren Buffett’s famous Berkshire Hathaway fund to illustrate the impact charges can have on long-term returns. Mr Smith says he is “not so much shocked as flabbergasted by the number of people who do not realise the impact of these performance fee structures”.

Taking typical hedge fund fees as an example – but widening his attack to performance fees charged by rising numbers of unit trusts and open-ended investment companies (OEICs) – Mr Smith said: “”As you are aware, Warren Buffett has produced a stellar investment performance over the past 45 years, compounding returns at 20.46 per cent per annum. If you had invested $1,000 in the shares of Berkshire Hathaway when Buffett began running it in 1965, by the end of 2009 your investment would have been worth $4.8m.

“However, if instead of running Berkshire Hathaway as a company in which he co-invests with you, Buffett had set it up as a hedge fund and charged 2 per cent of the value of the funds as an annual fee plus 20 per cent of any gains, of that $4.8m, $4.4m would belong to him as manager and only $400,000 would belong to you, the investor. And this is the result you would get if your hedge fund manager had equalled Warren Buffett’s performance. Believe me, he or she won’t.

“Two and twenty does not work. That does not mean that 1.5 per cent and 15 per cent is OK, or even 1 per cent and 10 per cent. Performance fees do not work. They extract too much of the return and encourage risky behaviour.”

Mr Smith, who was rated the best banking analyst in Britain for five consecutive years in the 1980s before going on to become chief executive of brokers Collins Stewart since 1996 is the latest City gamekeeper to turn poacher by blowing the whistle on established practice in the Square Mile. Like Alan Miller, a former senior fund manager at New Star, Mr Smith plans to launch his own fund management company, offering lower costs and higher returns to investors.

Whether either or both can pull off that double remains to be seen. But, here and now, there is growing resentment among investors about high charges and low returns. Earlier this year, The Daily Telegraph revealed how fund managers pocket more than £7bn a year from charges despite a decade of falling share prices. Mr Miller, a founder of Spencer Churchill Miller Private said: “The time is right for exposure of various elements of the industry.

“It is riddled with blatant self-interest and conflicts of interest that would never be tolerated elsewhere. Investors have become victims as the charges they have to pay have risen and risen while the returns they get have been consistently below par and the actual cost of managing their money has continued to fall.”

Data from Morningstar, a research company, shows the average investment fund has an annual charge of 1.25 per cent. But lesser known administrative fees amount to 0.45 per cent. And trading costs total another 1.35 per cent, according to the Financial Services Authority and Financial Express. When this 1.8 per cent is deducted from the total £406 billion invested, that amounts to £7.3bn being “skimmed off” each year.

Some fund managers have consistently delivered investor returns that more than justified their charges; Neil Woodford at Invesco, Evy Hambro at BlackRock, Robin Geffen at Neptune, Tom Dobell at M&G, Ian Henderson at JP Morgan and Job Curtis at Henderson are six that spring to mind. But many others have failed to do so and while investment returns remain low, interest in charges is likely to increase.

Few investors cared if annual management fees were 1 per cent or 2 per cent back in the 1990s when total returns often ran into double digits. Now they are glad to be grossing 6 per cent or 7 per cent, many more investors are much keener to keep costs to a minimum. Regulatory changes that take effect in 2012 will force further disclosure of costs and accelerate this trend. However much their former colleagues may hate them, Messrs Miller and Smith know which way the wind is blowing and are, as usual, ahead of the game.



http://blogs.telegraph.co.uk/finance/ianmcowie/100007842/warren-buffett-fund-illustrates-rip-off-management-charges/