Editor: The Number of Funds is Too Damn High

The learnings at Morningstar Investment Conference were plenty, but there's one thing sticking in Ollie Smith's mind, and (for once) it's nothing political

Ollie Smith 12 July, 2023 | 10:39AM
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Jimmy McMillan

I took away several learning points from our conference last week.

There is rank disagreement over when the UK’s rate hike cycle will end, for one.

For two, however, it’s very obvious pensions regulation has not yet caught up with the emergence of a new era of defined benefit pension scheme surpluses.

Throw in the realisation (courtesy of Steve Webb) that fertility pressures are creating a funding bottleneck for the state pension and you have three for three.

But there’s one thing that feels uniquely inconvenient to point out. Inconvenient not just to the many fund houses whose wares were on show at the event, but inconvenient to the extent that fixing it would probably hand my team less work. There are too many funds. 

Too Much Choice

It would not be unfair to characterise the rise in the number of mutual funds for sale as an explosion. In 2009, there were roughly 66,400 for sale across the world. By 2022, there were 137,892.

You could be forgiven for thinking this is a good thing – on the grounds the global fund marketplace has produced a tonne of consumer (and adviser) choice.

But then again: is it even good? The quantity of funds might make sense if they performed in the way their managers intended them to. 

Most mutual funds are actively managed by fund managers. And in the 2022 calendar year, actively-managed funds had a huge opportunity to prove their worth amid technology wobbles and the tilt back to value.

But they didn’t.

As Morningstar’s Active Passive Barometer report has shown, 2022 was somewhat of a disaster for active managers, who struggled to justify the higher fees paid by their investors.

"Undoubtedly this was a very difficult market, in which the Morningstar global equity index and global bond index both declined by 17% during the 2022 calendar year," Morningstar’s director of passive strategies research Monika Calay said earlier this year.

"This is the type of environment in which you would expect active managers to be able to outperform passive peers, but what we saw at year’s end was that only 29% of active equity managers were able to both survive and outperform their passive peers during the 2022 calendar year – so despite this unprecedented market environment, active managers in the active space were not able to produce an outcome that was superior to their index peers."

This kind of context puts even more pressure on consumers and their advisers to choose their funds wisely – lest they become one of the thousands of investors stuck in underperforming funds that fail to justify the fees investors pay for the pleasure of having their money managed by professional portfolio managers.

A Contrarian View

Is there a contrarian view? At MICUK last week, Calay returned to the fray.

Speaking on stage as part of a special debate on the future of active and passive investing, and then later directly to my colleague Sunniva Kolostyak on video, she very carefully (and rightly) argued Morningstar would never dismiss either approach – there is a future for both.

And not just because some active funds do genuinely prove their worth.

It’s also because the apparent failures of active management – and the costs of those failures – help to drive investors into the passive camp. In the UK this phenomenon is not yet as mature as it is in the US, but it is happening.

As demand for passive rises, it is easier for passive fund giants (like, say, Vanguard, which does also run active funds, for the record) to lower their fees, which benefits everyone.

It's good if you're a passive investor looking for a cheap solutions, and it's potentially good if you're an active investor too: that fund house of yours is going to feel some fee pressure.

If you’re in the passive camp, then, in a weird way you owe active investing a lot, even if you’ve never even bought an active fund.

There is still too much to sift through through. And one remarkable contributor to this phenomenon is ESG. Three years ago you couldn't move for ESG marketing, as fund houses raced to demonstrate their sustainability credentials.

Today, the European Union's sustainable finance disclosure regulation is forcing fund companies to clarify exactly what they mean by ESG. Tighter regulation in this space could help to limit greenwashing by funds that don't walk the walk.

Drain The Swamp

No investor could disagree: choosing the right fund for you – let alone the right share class – can be tricky. The amount of information is bewildering.

Will consolidation help? Normally I would cast my eye over the sheer amount of fund house mergers with a thinly-veiled contempt for the short-term machinations of business.

But one of the consequences, occasionally at least, is fund rationalisation. This happens when businesses close or merge funds that dramatically underperform, overlap, or just don't shoot the lights out. That too can help reduce the number of funds.

But there’s no point relying on fund rationalisation if the number of new funds continues to rise. Nor is there any point relying on hope alone. In the meantime, investors are left wading through the alphabet soup to find their fit. 

Independent Opinions. Expert Analysis. Timely Commentary.

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Ollie Smith

Ollie Smith  is editor of Morningstar UK

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