European retail fund managers have lost all contact with their customers. They have let intermediaries take full ownership of the relationship. The dominance of fund platforms has distanced them even further. This has proved a costly development.
Fund managers are generally reluctant to carp in public, but in private they admit to intense frustration. One chief executive of a large group recently told me power had shifted “somewhat dangerously” to distributors. They demand a third to a half, sometimes more, of the annual management fee in return for selling funds. Unless managers are prepared to sacrifice some of their own profitability, which would not go down well with shareholders, they have to raise charges, making their products more expensive.
“This makes portfolio managers tremendously angry because all those extra basis points we are paying for distribution they need to generate in extra alpha [outperformance],” the CEO fulminated. When a 70 basis points charge gets ballooned to 1.5 per cent to satisfy the distributor, that represents an extra 80 basis points of return a manager has to produce to beat the benchmark.
The high charges are a big contributory factor to the failure of many active fund managers to outperform.
The hope this fund boss harbours is that “direct distribution will rescue us”. He aims to cut out the middle man through an online platform that offers an advice tool and the type of bundled product with built-in asset allocation that advisers are unlikely to sell, “because they will stay in portfolios for 10 years and are not what makes money for an adviser”.
Getting into the direct distribution game will be a hard trick to pull off for individual groups, unless they plan to offer access to competing funds through their digital platforms. Investors have grown accustomed to a wide choice of funds from a range of management groups. Particularly in Europe, the big banks hold most of the cards when it comes to customer reach.
This is not good for the customers, as a new report from Morningstar underlines. The research group’s Second Global Investor Experience Study, which measures the investor friendliness of 22 countries’ retail fund markets on an A-F scale, gives most European countries a C+ or C rating. The only ones to rate an A are the US and Singapore. The latter scores particularly for its favourable tax regime and strong regulatory environment, says John Rekenthaler, co-author of the report. It only rates a C for fee levels. The US gets an A rating across three of the four criteria used for assessment, the exception being tax and regulation.
Few other countries get an A for anything. European countries, including the UK, score mostly Bs and Cs. New Zealand comes out worst, being the only one to score a D- overall.
Mr Rekenthaler says the US scores highly because of its low fees and strong disclosure. The report looks at asset-weighted fee levels, which helps the US, given the large low cost funds to be found there.
The US is a more mature fund market than most, which may account for why it is ahead of the rest. But as I have noted before, investors also benefit from the Vanguard factor. Mr Rekenthaler points out that John Bogle, Vanguard founder, has been appearing on television for the past 25 years reiterating his simple message that costs matter. There is no one like him anywhere else, he says.
US investors have increasingly favoured low-cost funds, he adds. Ten years ago, flows were going equally to low-cost and high-cost funds. In 2009 when he last looked at the issue, splitting funds into groups charging less than 25 basis points, 25-50 bps, and so on, every group above the 50 bps mark had suffered net redemptions.
Another plus for the US is its bar on one-way performance fees (except for hedge funds). Managers that charge performance fees have to make them symmetrical, and few have the courage to take that test.
Despite the apparent superiority of the US on the fee front, Mr Bogle makes clear in his recently published book Don’t Count On It that he thinks most fund managers still charge too much. Fee rates may look low, but in dollar terms, managers are doing nicely thank you, raking in $69bn of fees compared with $12bn in 1990.
Canada, by the way, is the only market to score an F for fee levels. The average asset weighted expense ratio for equity funds there is 2.4 per cent, says Mr Rekenthaler. Canadian fund managers complain in private about being held to ransom by distributors, just as their European counterparts do. Both sets of managers are profitable, though. It is the investors who are losing out.
Without a John Bogle to do battle on their behalf, they will probably continue to do so.