Most fund managers will not beat the index. This premise was predicted by Modern Portfolio Theory in 1952, and has been validated by numerous researchers since then.

As Buttonwood wrote in the Economist in June 2017:

“It should not be a surprise that the average fund fails to beat the index. The “iron law of costs” is that, in aggregate, professional fund managers own most of the stockmarket. Thus their performance is highly likely to resemble that of an index that tracks the overall market. But the index does not incur costs or fees; fund managers do.”

The “iron law of costs” is of course the reason why passive low cost ETFs are becoming so popular. 

Canstar research shows higher fund manager costs do not generate higher investment returns. No matter what they are called, whether it be management fees, transaction fees, performance fees, account fees or administrative fees, there is no evidence that higher fees translate to higher investment returns. This is so notwithstanding common contrary claims from the fund management industry.

Active manager fees are usually very high, ranging from an average of 0.47% on simple cash and fixed interest funds to nearly 3% on large cap global share funds. Compare this to 0.2% for some passive index funds.

Canstar tabulate the range of management fees as follows:





Australian cash and fixed interest




Australian shares- large cap




Australian shares- Mid/Small cap




Global bonds




Global shares – Large cap




Multi-sector aggressive




Multi-sector balanced




Multi-sector growth




Multi-sector moderate




(Source: Canstar website December 2017)

Let’s say the average fund manager costs your client 1% a year. If your client invests say $500,000 that’s $5,000 a year, every year, no matter how poorly the manager performs. Over time the opportunity cost, ie the manager fee plus the under-performance, really adds.

Let’s say the average adviser has $20,000,000 FUM. That’s $200,000 a year of fees to fund managers…

How much does the average adviser earn? Well, it obviously depends, but I am fairly certain many, if not most, earn less than $200,000 a year.

Why would an adviser earning $200,000 a year refer fees of $200,000 a year to a fund manager if they can do that work themselves? It does not make sense. Why not do the work yourself and double your income?

But it’s not just profit maximisation and goodwill maximization that is at risk. We are increasingly seeing fund managers step around the referring advisers to deal directly with the adviser’s client, and we have evidence of fund managers asking the regulators to prioritize the fund manager-client relationship over the adviser-client relationship. We expect to see more of this as digital marketing and AI becomes more sophisticated. 

A wise adviser sees the fund manager as their future competitor, not their future partner.

So why do advisers use fund managers?

For me the answer is more likely to be habit and indoctrination than a sensible business decision.

Most advisers have institutional backgrounds and, obviously, institutional AFSLs require their institutionalized advisers to use their institutionally owned fund managers. The institutional adviser has no choice. On leaving the institution the habit is hard to break. It’s a classic Pavlovian response. But it is a habit that should be broken. The simple reality is most advisers do not need most fund managers. The adviser should do that work or, if you like, the adviser should be the fund manager.

By the way, when was the last time a fund manager referred a client to you? Who do you love more? Your children? Or your fund manager? 

Step up and control the entire advice process yourself. Technology enables it. Skip the fund managers and recommend your client  invest directly into a simple and safe parcel of low cost index based ETFs. Its passive, the science says it will beat most active managers, and it will cost your client a lot less than the average 1% charged by the average active fund manager.

A similar case can be made for not using a platform.Why use a platform? As clever as they may be, you just don’t need one for a small stable long-term cost-minimized index based ETF portfolio. Nabtrade or Commsec will record all relevant transactions for you, and they are virtually free. Save costs and skip the platform.

Obviously its courses for horses. Your advice must be appropriate, in your client’s best interests and prioritize your client’s interests over everyone else’s. But most clients with significant monies to invest outside their home will be suited to holding a series of index based ETFs in their own name, or through a SMSF, a company or a trust. Your statement of advice should emphasis control, and low costs. Link in articles on Modern Portfolio Theory. Quote Warren Buffet. Demonstrate to your client that your advice is likely to leave them better off financially. This is, of course,what ASIC says, in Part E of RG 175, is the bottom line on the best interests duty: would a reasonable financial planner agree your advice likely to leave your client materially better off? 

The answer is definitely “yes”: economic history and theory both predict an adviser supervised, small, stable, long-term, cost-minimized, passive index-based ETF portfolio will beat the actively managed managed fund, and will cost your client a lot less. 

In a fee for service world step one is to first provide the service. Don’t refer the service and the profit on to someone else. Get the profit for yourself.

That SMSF, company or trust opens up new opportunities for improved inter-generational financial planning, better super planning, and better tax planning. Introduce a judicious and careful amount of low cost and tax efficient debt, to lever higher long-term profits. Its more better-off-ness for your client, more work for you and more fees for your practice.

The adviser who becomes the fund manager has higher profits, higher practice goodwill and a more stable and secure practice.

There will be significant less risk of disruption when a fund manager decides your clients are its clients….

[1](Why is the multi-sector maximum just 1.58% for moderate, 1.95% for growth, but 2.5% for balanced? I have no idea. I cannot understand why balanced costs less than growth; surely there would not be any extra work: it’s just different weightings, not different underlying investments?)