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What the fund managers don’t want you to know

70% of active retail fund managers failed to beat the S&P /ASX 200 Accumulation Index over the five years to June 2012, but charge a fee ten times higher than Vanguard’s Australian Shares Index ETF.

Research by Standard & Poor’s shows that performance was even worse over one year and three years, with more than 70% (1-year) and 80% (3-years) of active fund managers unable to beat the index. According to Morningstar, the average retail investment fee for an actively managed fund tracking the S&P / ASX 200 Index (Index: ^AXJO) (ASX: XJO) was 1.59%, while the listed Vanguard Exchange Traded Fund (ETF) charges a fee of just 0.15%.

And it doesn’t end there. Index funds adopt a buy and hold strategy, only selling out of some stocks on a quarterly basis, as stocks get taken out of the index, resulting in lower transaction costs and less tax on capital gains. Hence the reason why many fund managers will still quote their performance as gross returns before fees and tax.

Unfortunately there’s more bad news with many retail investors also being charged commissions by financial advisers, making it almost impossible for them to beat the index return over sustained periods.

And many of Australia’s fund managers are index huggers. In other words, there is not much difference between their portfolios’ major holdings and the main stocks listed on the index. The big four banks, Telstra Corporation (ASX: TLS), Wesfarmers (ASX: WES), Woolworths (ASX: WOW) and either one or both the big miners, BHP Billiton (ASX: BHP) or Rio Tinto (ASX: RIO) and usually the biggest holdings in fund manager portfolios.

While investment advisors to the fund managers believe that active managers can beat the market, the evidence suggests not, and very few active fund managers will beat the index consistently. The issue is that the investment advisors have a conflict of interest and without active managers would likely not exist. While some cite evidence that small cap active managers have regularly beaten the Small Ords Index, simply avoiding small resources stocks would have delivered the same result over the past few years.

Foolish takeaway

The best thing investors can do is take control of their investments and superannuation. Check the fees that you are being charged, and the performance (after tax and fees) that your managed fund is delivering, compared to the index. If they aren’t beating the index consistently, then you need to consider other options.

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Motley Fool writer/analyst Mike King owns shares in Telstra, Woolworths and BHP.

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