April 28, 2011 7:20 pm
Funds that have US managers tend to perform better over longer time periods than those from the UK, according to research that throws a spotlight on the impact of high fees on investors’ portfolios.
Global equity funds in the US returned 32 per cent more to investors in the past 15 years than similar products in the UK, according to research by Lipper commissioned by the Financial Times.
In the decade to the end of March, US-based funds performed better on average in all the sectors studied, including Japan, Europe and global bonds.
Analysts say the most likely reason for the difference in performance is fees. US funds have, on average, significantly lower total expense ratios than their UK counterparts, at 0.94 per cent compared with 1.67 per cent, according to Morningstar.
Ed Moisson at Lipper, who carried out the research, believes that independent boards of directors in the US have a big impact on lowering fund fees. “They have an attitude that every basis point counts,” he says.
US mutual funds are required under the Investment Company Act of 1940 to have a majority of independent board directors who have the task of keeping fees down. In the UK, directors of unit trusts are employees of the fund management company.
Studies have drawn a direct link between how expensive a fund is and how well it performs. A report last year from Morningstar found that in every single time period tested, low-cost funds beat more expensive funds.
US funds are less expensive than UK funds in part because private investors in the US are more cost-aware than those in the UK.
A study in 2006 by the Investment Company Institute, the US trade body for mutual funds, found that fees came top of the list for investors when deciding which fund to pick.
“A marketplace that’s aware is one that puts more cost pressure on the funds,” says John Rekenthaler, vice-president of fund research at Morningstar in Chicago.
Some point out that the US mutual fund market, as the world’s biggest, is so much larger than the UK’s that it enjoys far greater economies of scale.
But Rekenthaler says that Morningstar’s calculation of an average 0.94 per cent expense ratio for US funds is asset-weighted.
US funds also differ from UK funds in that not all include fees to cover commission payments to advisers. In the UK, 50 out of the standard 150 basis points charged per year is earmarked for a financial adviser (regardless of whether any ongoing advice is being given). In the US, some funds are “no-load” – with the cost of distribution stripped out.
Many expect that UK fund fees will come down after the Financial Services Authority’s shake-up of the financial advice industry, known as the Retail Distribution Review, in 2013. A ban on commission will mean that the standard 0.5 per cent “trail” will no longer be paid out on new funds.
The Investment Management Association says it is not yet clear how fund fees will be affected by the RDR.
But commentators point out that a move by financial advisers in the US more than a decade ago towards charging fees created more pressure on fund companies to lower their charges.
Rekenthaler says fees first became a hot topic in the US after the tech bubble, when many financial advisers moved to a fee-based model and started putting pressure on fund management companies to improve returns for investors by cutting their costs.
“Advisers want fees themselves, so it stands to reason that the less customers pay the funds, the better off they are,” he argues.
Tom Rampulla, managing director at Vanguard, which launched its first low-cost funds in the UK in 2009, agrees that UK investors are less cost-sensitive than their US counterparts.
“Before entering the UK, we saw a real opportunity for a low-cost market as the industry here isn’t transparent – no one talks about costs,” he says.
“Lowering costs in the US took place over a couple of decades and now there’s a bit of a price war in the US over costs. We think, and we hope, that the UK will go the same way.”
Ahead of the RDR, some UK active fund managers have begun to launch so-called low-cost funds. Schroders and JPMorgan Asset Management both now have funds charging as little as 0.4 per cent a year. Rampulla, however, is sceptical about how radical the moves made so far actually are.
“Consumers will really benefit when they lower costs on established funds with good records that are truly actively managed,” he argues.
Active fund managers in the UK are keen to point out that passive funds, including exchange-traded funds that are growing in popularity with retail investors, cannot add value and will often slightly under-perform the index they track because of added costs.
But Rekenthaler notes that active fund managers in the US no longer try to push this message.
“There’s a general sense that the savvy investor is one who realises that active managers are overpaid salesmen and you’re better off not listening to the nonsense and buying an index tracker,” he says.
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