More than a fee-ling

Why do investment companies tend to outperform their equivalent open-ended counterparts, as independent studies consistently suggest they do? For many years, the simplest explanation was that investment companies were cheaper: with smaller fees to drag on performance, they automatically did better.

In recent times, however, this argument has looked less clear cut. Since the retail distribution review (RDR) five-and-a-half years ago outlawed all commission payments in the investment industry, open-ended funds that previously made such payments to advisers have been able to substantially reduce their charges. Investment companies have never been allowed to pay commissions, so RDR did not produce the same dividend for this side of the industry.

The result, to a large extent, has been a levelling of the playing field. Open-ended funds have tried hard to take the fight to investment companies on cost.

Now, however, investment companies are fighting back. Over the last two to three years there has been a clear trend towards lower fees, with many boards and managers cutting charges and rethinking their charging practises.

In the second quarter of the year alone, trusts changing their fees included BlackRock Smaller Companies, Templeton Emerging Markets, Fidelity China Special Situations, Monks and Securities Trust of Scotland. There have been many more over the past 18 months or so.

There will be further reductions in the months and years ahead. Fidelity Special Values, for example, last week announced a revamp of its charges, which will take effect from September. It is introducing a tiered structure: the fund, currently valued at around £750m, will charge 0.85 per cent a year on net assets of up to £700m and 0.75 per cent on assets above that value (today a flat rate of 0.875 per cent applies).

Fidelity’s decision is a particularly interesting one. As well as recognising the case for lower charges, the trust is also acknowledging the economies of scale that occur as assets under management grow. It is right that investors, as well as the manager, should benefit from these economies.

Investors and advisers will welcome these fee reductions. Everyone likes paying less, of course, but it’s also encouraging to see the investment industry focusing on actually delivering more value, rather than getting caught up in the endless debate about transparency that financial regulators so enjoy. In fact, the industry seems to be cutting its charges in spite of the regulation rather than because of it.

Where does that leave the debate about the relative performance of investment companies and open-ended funds? Well, if the charging differential between the two structures is narrowing, something else must be going on too since there has been no corresponding fall in the performance gap in recent studies.

Investment companies do have other attributes that contribute to outperformance: their ability to take on gearing is one advantage while the closed-ended structure of these funds makes it easier for the manager to do his or her job, with no concerns, for example, about the need for a cash buffer to cope with inflows or outflows.

These advantages appear to be sustaining the sector even where its cost advantage in some cases could be shrinking. That’s good news for investors and advisers alike – lower charges with no detrimental effect on performance represents a compelling proposition.