Managed Fund Pitfalls

Managed funds are also known as pooled investments, managed investments, managed products, equity trusts, mutual funds. They are sold by bank wealth managers, financial planners and stockbrokers.

Managed funds have several major disadvantages:

  1. High fees

There are numerous fees, many opaque, which can include entry-exit fees, management fees, performance fees, buy-sell spreads, transaction costs, administration fees, trustee fees, custodian fees, platform fees, and fund-of-fund fees.

Investors need to be aware that they are paying these underlying managed product fees and costs, in addition to wealth manager’s or financial planner’s fees.

You can easily be paying upwards of 3% or more per annual in total fees, and not know it!

  1. Underperform

The industry’s best kept secret is that managed funds, in aggregate, underperform the market!  The reason for this underperformance  is because most active managed funds follow a de facto index investment strategy of only matching the market, for fear of otherwise falling behind it and investors redeeming. Size, numerous fees, high turnover transaction costs, and cash reserve requirements, further reduce performance.

“You often get investors [managed funds] who are really closet indexers, in which case you are being played for a sucker. These guys have 85 per cent of their assets linked to the index and they charge big fees.” Warren Buffett

  1. Tax disadvantaged

There are serious tax issues. New investors inherit the fund’s unrealised capital gains on the stocks it owns, and will be required to pay tax on these gains when the stocks are sold! New investors dilute unrealised capital losses, which disadvantages existing unit holders. Capital losses cannot be distributed to unit holders to offset against capital gains outside the fund.

  1. Not transparent

Managed funds lack transparency because capital, income and fees are commingled into a single figure, the unit price. You are literally in the dark and budgeting is impossible. With a directly owned stock portfolio you know exactly what your capital value and dividends are, and can budget accordingly. Similarly if you own an investment property. You know exactly what its income is, which is separate to the property’s value.

  1. Lack security

The best absolute and ultimate security is always to have the title of the stock, or property, registered directly in your own name.

With managed funds you own units in the fund, but not the actual underlying investments. Incidence of fund manager fraud have cost investors in the past.

  1. Investment inefficient

Managed funds must maintain cash reserves to cover redemptions. New money contributed to a managed fund can also take time to invest. Holding part of the fund’s assets in cash means the fund is always under-invested, missing out on the full potential of owning stocks. This is another factor contributing to under-performance.

  1. Not portable

You can become locked-in to a managed fund because, if you decide to take your money elsewhere, you are forced to redeem your investment and pay any capital gains taxes. No such limitation applies to a directly owned portfolio of stocks.

There can be other problems as well such as income being paid from capital, and excessive brokerage charges subsidising  fund manager research.

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