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Baillie Gifford's Coutts: fund 'euthanasia' is long overdue

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Baillie Gifford's Coutts: fund 'euthanasia' is long overdue

Baille Gifford partner Tom Coutts believes the way the fund industry charges clients has reached its tipping point. 

In a note titled 'Riding the Gravy Train', Coutts described the inflexion as 'unambiguously good'. 

He wrote: 'Such a comment may sound odd coming from a fund manager, but we have never held the wider investment industry in high regard. 

'It seems to us that most funds’ fees are too high, most so-called investors’ time-horizons are too short, and most firms operate with their eyes focused inwardly on their own interests rather than outwardly on their clients’.

Coutts' comments followed fellow Baillie Gifford partner Stuart Dunbar's suggestion that fund managers' 'social licence is broken' published exclusively on Wealth Manager last March.   

Both the commercial pressures of ever-cheaper beta products, and regulatory scrutiny of how much value is added by fund managers, have ramped up pressure profit margins in recent years. 

Coutts noted that being largely made up of intermediaries and agents,  finance creates little of value and those who work in it could show more humility. 

'It [the financial industry] is a facilitator, a lubricant for the economy, helping savers to earn a good return on their money and providing financing for investment opportunities, from the funding of a new car to the construction of a spaceship.'  

'Those of us who work within it should be humble about
the role we play. That, generally speaking, such humility is lacking.'


Wal-mart sold at Whole Foods prices  

He said the investment industry too often does a poor job for a high price.  'Like the US grocery industry in the 1960s when Sam Walton started Wal-Mart, there are too many people charging too much,' he said. 

'There is a large pool of investors that just wants simple products at a low price, and they should seek out the investment equivalent of Wal-Mart.' 

Coutts acknowledges there is a large part of the market that is willing to pay slightly more for a significantly better product. However, he stresses that product needs to be genuinely better so clients feel like they are getting good value for money. 

'At the moment we have the unsustainable position of too much Wal-Mart product being sold at Whole Foods prices.'  

'[But] by the same token, genuinely differentiated investment strategies that deliver longterm value for their clients should not
be sold at discount-store prices.' 

How high should fees be? 

Coutts believes for a more perfect pricing system, there should be a positive relationship between risk and reward.

He labels the pricing philosophy across the industry as 'perverse'.

'The current structure of investment management fees leaves the manager’s reward guaranteed, at least for a period of time, and the client bearing the risk of an uncertain outcome.

'The rule of thumb seems to be that asset managers should reasonably share around a quarter of the gross value added above the benchmark return.' 

In Coutts' view, the industry should evolve to a model based on a low base fee, sufficient to cover the costs so that an asset management firm can continue to invest during those inevitable periods when results are poor. He suggests this could be combined with a sliding and capped performance fee. 

'The base fee might, for instance, be 20 basis points, and the performance capture a fifth of the total above 1%,' Coutts advises. 

'[Instead] of the hedge fund industry’s infamous "two-and-twenty",
we would end up with something closer to "point-two-and-twenty", striking a far better balance between the interests of client and manager.' 

Too many spoons in the bowl 

Coutts goes on to offer a range of suggestions on what the investment management industry should look like, which should show a greater awareness of its role in society. 

Within this he outlines the distinction of passive products. 'There should be a decent proportion of assets allocated to passive managers, who offer a low-cost benchmark for the active industry to beat – they are the Wal-Mart of the investment industry.' 

However, he stresses passive funds must actually be low cost. 

'There are tracker funds in the UK with annual management fees of 1%! [And] we should be clear that the whole industry can’t go this way: at one level passive investing isn’t really investing at all, it’s buying cheap market access. 

He adds that the ultimately size of the industry has only been economical due to excess charges, and that a fair crack for fund buyers will inevitably mean the overall industry needs to shrink.

'There are currently too many spoons in the bowl, too many managers extracting rent from the assets belonging to long-term savers. As in any other industry, firms offering me-too products or failing to add value for their clients should go out of business. The euthanasia of some of these particular rentiers is long overdue.' 

Tom Coutts joined Baillie Gifford in 1999 and spent a number of years in the firm's UK Equity and European Equity teams before moving full-time to the EAFE Alpha Team in 2017. He became a partner in 2014.




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