Good reads from around the Web.

Tons of links this week, so I’ll just kick things off with a Bloomberg piece about bear markets and robo-advisers.

Bloomberg notes:

The rise of these robots and their automated investment strategies has largely coincided with a multi-year bull run in stocks, which means the nascent industry could face a big test if markets were to turn.

A bear market would represent a challenge that the ranks of robo-advisers haven’t encountered yet, and it would be the ultimate test of just how crucial, or irrelevant, working with actual humans is to good, long-term investing.

It seems the tech-savvy Millennials who were first to adopt these passive and automated robo-strategies aren’t really paying much attention to the markets, compared to previous generations.

As Monevator regulars will know, such wilful ignorance will likely see them earning superior long-term returns.

The question is: Would a market crash that’s severe enough to cause ripples even inside their streamed flat white flooded artisanally crafted investing goldfish bowls (figuratively speaking) prompt them to dig out their robo-account passwords to meddle with their portfolios at exactly the wrong time?

We’re not in Kansas anymore

Pull back the curtain on all the grand mysteries of investing, and you’ll discover – nowadays especially – that simple can be most effective.

It’s easy to construct a passive portfolio. You can do it with a robot service or by investing in as few as two ETFs.

Rebalancing isn’t hard, either, whether you’re DIY-ing it or having a robot (or a blended offer like Vanguard’s LifeStrategy funds) take the strain.

The difficult part is learning why most people should take a passive approach in the first place.

And then to have the knowledge to stick with it during the tough times.

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Good reads from around the Web.

Last week’s Weekend Reading was about fund fees, but the comments became a – um – spirited discussion about currency risk in post-retirement portfolios.

It was an argument caused by different perspectives as much as about the facts.

A similar thing often happens when we talk about investing risk.

Often when people say one investment is less or more risky than another, what they’re really describing is transforming risk from kind into another.

In the currency debate, I noted the shortened time horizons of a retired person and the need to spend your pot in your domestic currency to meet your day-to-day living costs made currency risk more important at 65, say, than when you’re saving into a pension at 30 and can take a sanguine long-term view.

I suggested a greater allocation (note: not 100% or anything like it) to your home stock market might therefore make sense, as might hedging a portion of your overseas exposure (again, not all, just a portion to dampen the swings).

The other side bridled at the consequent higher costs – even if those costs were just a hypothetical 0.25% extra annual charge applied to just a bit of the portfolio.

The 0.25% cost was a nailed-on expense to be paid every year of retirement, they pointed out, whereas the impact of currency risk was unknown. Better to risk a bigger hit to your retirement income from currency swings than to guarantee a modest hit by paying that charge every year.

For richer or poorer

How often do we get into similar disagreements when debating finances?

(Okay, not very often if you’re a normal person into football or Facebook – I mean us personal finance nerds!)

Paying down your mortgage versus investing, whether or not you should buy an annuity in retirement or to stay in shares and bonds – they’re not really arguments with the “right” answer, because they depend so much on your risk tolerance, your circumstances, even your philosophy of life.

Sticking with the retirement theme, retirement researcher Wade Pfau posed one of these eternal questions directly this week in his article: Which is better for retirement, insurance or investments?

Pfau wrote:

There are two fundamentally different philosophies for retirement income planning, which I call probability-based and safety-first.

Those philosophies diverge on the critical issue of where an individual is best served to place their trust: in the risk/reward trade-offs of an equity portfolio, or on the contractual guarantee of insurance products.

The fundamental question is about the type of strategy that can best meet the retirement income challenge for how to combine retirement income tools to meet goals and manage risks.

Those favoring investments rely on the notion that the market will eventually provide favorable returns for most retirees […] There is also a general unease about relying on the long-term prospects of insurance companies or bond issuers to meet contractual obligations.

Perhaps not fully understanding the implications of how sequence-of-returns risk differs from market risk, the belief is that in the rare event that the performance for the equity portfolio does not materialize, it would imply an economic catastrophe that would sink insurance companies as well.

Meanwhile, those favoring insurance believe that contractual guarantees are reliable and that an over-reliance on the assumption that favorable market returns will eventually arrive is emotionally overwhelming and dangerous for retirees […]

Even if there is a low probability of portfolio depletion, each retiree gets only one opportunity for a successful retirement.

This is the annuity versus income-portfolio-in-drawdown debate taken back to first principles.

At different times one approach might have an edge – when annuity rates are low, say, or stock markets scarily high.

But ultimately it’s a matter of philosophy and risk.

For better or worse

Coincidentally, Michael Kitces also published a really huge article comparing a whole bunch of different retirement strategies.

Again the same issue comes up:

What seems like a relatively simple question – which retirement income strategy is the best – is actually remarkably difficult to determine.

Because as it turns out, which is “best” depends heavily on how you measure what “best” really means in the first place.

This is a really in-depth article with some excellent graphs, and while it’s written from a US perspective there’s a lot to think about wherever you’re retiring.

Kitces also produced a table showing how the various strategies perform very differently across a range of outcomes:

One retiree’s pleasure is another’s poison.

Now, if you’re having a debate with someone who is most interested in (potentially) maximizing their final wealth, putting forward a strategy where at least some modest success is the top priority will cause some friction – unless maybe you both take a look at this table before you start your argument!

Retirement solved – and sold

You can also see from the table how the financial industry is able to spin the same problem into half-a-dozen different products for sale.

And that’s fine, if they’re providing different solutions for different needs.

But it can also be a misleading spin that says their favoured solution gets rid of the Worst outcome of some other hateful strategy – without pointing out the downsides of their own approach.

Remember, there are no free lunches in investing. Especially when you’re paying!

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Good reads from around the Web.

Always nice to see the rich and the powerful do something good with their money. And so nice to see Neil Woodford, the famed fund manager, leading the way on fee transparency.

The Woodford Funds blog says:

From 1 April, investment research costs are being paid by Woodford, rather than by the fund with no increase to the existing annual management fee.

We also commit to greater transparency on the total cost of investing, with all transaction costs to be disclosed monthly on our website.

[…]

The cost of transacting is wrapped up in the cost of buying or selling assets within a fund – they are an inevitable part of investing. All stock market investors, whether fund managers or DIY investors, face these costs, which come in the form of commission and, when buying shares, Stamp Duty.

From 1 April, one element of the cost of transacting – that of research costs – are being paid by Woodford, rather than by the fund.

Importantly, we are not increasing our fees to cover this additional cost.

Investors are, in effect therefore, getting a price cut, which will immediately benefit the future performance of the fund.

Of course, some say this is all a big PR move. That Woodford is doing this because with his huge and loyal following he can get away with it.

Well if it’s a PR move then it’s probably an expensive one.

As for his huge and loyal following, Woodford achieved that through several decades of outperformance in various market conditions and now at two different companies, which personally I am happy to take as evidence of a unicorn-rare ability to beat the market through skill – at least in the past.

Perhaps he could have instead taken his huge and loyal following for a ride, and charged higher than average fees – just like all those famed hedge fund managers do, with their 2% charges and 20% performance fees?

Woodford went the other way. Good for him, I say.

Saint or scandal?

Robin Powell at The Evidence-Based Investor isn’t so easily impressed:

Neil Woodford can afford the smartest spin doctors, and it shows.

Hardly a day goes by without a Woodford story (almost invariably positive) in the media.

The latest success for his PR machine came this weekend, with the announcement that the Woodford Equity Income fund will now absorb its own research costs, rather than charging them to investors.

This is, of course, good news for investors, and let us hope that other fund managers will follow Woodford’s lead.

But it needs to be kept in context.

That Woodford Investment Management, along with almost every other UK fund management company, was asking investors to pay its research bill in the first place is a scandal.

Personally, I’m not that bothered about investors being charged for research. Scandal, for me, is far too strong a word.

The whole argument for paying for active fund management is so flawed in the majority of cases – for the simple fact that they fail to beat the market – that if you do find a fund manager who can consistently take the market behind the bike shed for a drubbing – to outperform, after all fees – then let them keep the lights on however they see fit, I say.

Complaining that an active fund manager who, for instance, trailed the index for a decade – and cost you 2% a year in fees and charges in doing so – partly reimbursed themselves through a 0.02% research bill seems to me a bit like being bothered that the alien walkers in War of the Worlds stood on your front lawn on their way to obliterating your village.

Moreover, charges in financial services are like Wac-A-Mole. If a fund manager wants to – and believes it can – take some particular annual tithe from its customers, it will find some combination of fees they will pay. At least research is (theoretically) useful to an investor.

Of course, I understand the other side of the argument – that investors are clueless about all these fees, and that by unbundling and revealing them they will become less happy to pay them, and so will pay less.

But will they? The experience from the unbundling that came with RDR was that for many (including some passive investors, due to higher platform charges) the cost of investing actually rose.

Anyone who does a day’s research will discover the cheapest and best way for most people to invest is through index funds on low-cost platforms.

If they are not already discovering that – or they don’t care – then is a long list of bullet points on the back of a factsheet detailing every last bill paid by a fund really going to change their mind?

Will the average consumer even read it?

I have my doubts.

What’s it worth?

Partly I am playing Devil’s Advocate here. Clearly everyone at Monevator Towers thinks such information is better out than in, for those who do want it.

But to be honest I find it hard to get overly worked up about it.

There are other issues to consider, too, such as the average consumers’ limited understanding of what fund charges actually describe.

As one industry commentator puts it in the FT (search result):

“[Mr Woodford] has launched a modern asset management business, performance has been excellent and I know he has a low turnover style,” said Mr McDermott.

“Some funds will trade more and have higher costs — but it’s not necessarily a worse fund. It’s important to look at the alpha generated.”

“It’s not as straightforward as ‘this one costs 84 basis points, this one costs 120 basis points and I’m going to buy the cheaper’,” he added.

One of the most consistent (and opaque) hedge fund managers in the world, Renaissance Technologies, has achieved annualized returns of over 35% a year for 20 years.

It is a quantitative trading house that uses vast warehouses of data to find patterns or inefficiencies in the market. I don’t have numbers on its annual portfolio turnover, but it’s routinely described as a pioneering high frequency trader. I imagine they’re huge.

If Renaissance’s edge is partly expressed through churning its portfolio, then investors who’ve made a fortune from it would have been ill-served by dumping it after receiving their first monthly investment letter that quoted a scarily high annual turnover.

High turnover is ruinous to most active funds. It is costly. Renaissance and most of the handful of other market-beating exceptions will never be accessible to you or me. And the average active fund’s cost is just a tax on your investments.

All true. But it requires a lot more understanding to discover this and to realize what it means for your future strategy than can be communicated by a lengthening list of fees in the small print – incomprehensible to most.

The end of an era, anyway

What I’m saying is that high fees are high fees, however they’re sliced and diced.

What will do for active fund managers is the realisation that they’re very rarely worth the price on the menu – and that cheap tracker funds can take their place – rather than a micro-investigation into how they charge for their ingredients.

Bloomberg calls this the financial services industry’s “Napster Moment”:

Just as record companies in the early 2000s had to deal painfully with the digitization of music courtesy of Napster and Apple Inc.’s iTunes, many asset managers are now facing a similar situation as more investors make the switch from high-priced, actively managed mutual funds to passive, low-cost, exchange-traded funds (ETFs) and index funds.

When the dust settles in this sea change, the financial industry may be half of what it once was, simply because its revenues will be half of what they once were.

It is the low costs of passive funds and the huge underperformance of active funds that is driving this sea-change, not a detailed examination of how those high active costs come about.

Rhetorically speaking, if I found an active fund that I was certain would handily (and legally) beat the market – after all fees – for decades to come, it could bill me for strippers and Lamborghinis if it wanted to.

There’s nothing wrong with transparency – except perhaps its potential to confuse customers (which is a line that sounds awfully financial service-speaky, so I won’t push it further today!)

But for me it’s very much a skirmish on the sidelines in the wider war.

Reasonable minds can disagree, though.

My co-blogger I suspect thinks very differently. (He’s away at the moment so I can’t ask him). Robin Powell of the aforementioned Evidence-Based Investor does for sure.

In fact, Robin has even joined something called the Transparency Task Force. When it comes to its broader stated aim of exposing or publicizing the excess costs inherent in so much of the financial system, I can only wish it well.

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