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Revealed: The problem with active unit trust funds

by , 31 July 2013

The biggest problem with active unit trust funds is not necessarily that fund managers are bad at investing on the whole. Some studies suggest that overall, fund managers are better than most people at picking stocks (as you'd have hoped!). Read on to find out the biggest problem with active funds…

Before we go any further, let’s define a unit trust fund…

A unit trust fund is simply when you pool your money with a lot of other investors, and give that money to someone else to manage, explains John Stepek of MoneyWeek.

These unit trust funds can either be actively managed or passively managed.

‘Active’ unit trust funds employ a fund manager, who aims to beat the underlying market, by using their investment skills to pick and choose different assets.

This is in contrast to a ‘passive’ unit trust fund – also known as a tracker fund. This fund merely tries to copy the performance of the underlying market.

The biggest disadvantage of active funds is costs

The big problem with active funds is costs. A typical actively managed fund charges you 1.5% of the amount you’ve invested each year. A typical tracker fund will charge less than 0.5%.

You might already be seeing the problem here. To have any hope of beating the market, the fund manager has to make enough money both to beat the market, and to pay for their own costs.

That might not sound like much, but a simple example might put it into perspective. Say you invest R100,000 at 1.5%, then leave it for 20 years.

Let’s assume that it grows at the (somewhat optimistic) rate of 7% a year. By the end of 20 years, you have around R290,000.

Now take the same investment, and the same returns, but cut the fee to 0.5%. After 20 years, you’ve got around R350,000.

That’s a huge difference.

Are active funds ever worth it?

This argument seems to make the case for passive funds very strong. And that’s because it is. But tracker funds do have some problems.

But logically speaking, if you have no real idea of whether your ‘active’ manager can actually beat the market, then it makes far more sense to buy a fund that will at least track your chosen market.

There are times when it can be worth paying the extra for active management. You may not always be able to find a passive fund that tracks the sector you are interested in.

Or you may have found a fund manager with a consistent strategy and a good track record that you are happy to invest with.

But the point is that active funds are expensive compared to passive funds. So if you are going to go down that route, you should make sure that they are worth it.

What you should do now…

Look at your current portfolio. If you have any funds, are they actively managed or passively run? If they are actively managed, then how does the performance compare to the benchmark index? Are they worth the fees? Or would you have been better off just tracking the market?

Revealed: The problem with active unit trust funds
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