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The price is right

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28 December 2018

David Prosser highlights continued efforts by the sector to cut and restructure fees.

There was a time when the debate about the respective merits of different types of fund was straightforward: investment companies were cheap, giving managers a headstart as they sought to outperform; open-ended funds were more expensive, with managers dragged back by the need to pay commissions to independent financial advisers. Then along came the retail distribution review, the regulatory shake-up that outlawed commission payments, and the picture began to change.

Six years later, it is no longer possible to flatly state that investment companies cost less than their open-ended equivalents. Freed from the need to offer commission payments, which were always against the rules for investment companies, open-ended funds have cut charges aggressively. Many are highly competitive – in some cases, they’re even cheaper than comparable investment companies.

The good news for investors and advisers is that the investment companies sector continues to respond to this competition. During 2018, 37 investment companies cut their charges, up from 27 funds that made fee reductions during 2017.

The result, according to research just published by Kepler Trust Intelligence, is that the average ongoing charge on an investment company has fallen by 0.08 percentage points over the past 12 months. And in some areas of the market, the reductions have been even more dramatic. The typical private equity fund now costs 0.34 percentage points less than a year ago according to Kepler.

Fee reductions take different forms. In some cases, managers are simply reducing the headline annual management charge levied. In others, charges are being restructured. We are seeing more use of tiered charging, where fees are reduced on assets under management above a certain level. Performance-related charges are becoming much less common.

Often, these changes reflect pressure from the independent boards whose job it is to hold investment company managers to account on behalf of shareholders. Managers recognise, of course, the need to stay competitive on charging, but boards have a platform and a mandate to press the point; often, they have been able to secure reduced charges from managers that might otherwise not have moved.

This is healthy. Investment managers sometimes complain that advisers get overly fixated on the issue of charging when what they should really worry about is long-term performance. But while it’s perfectly true that what investors care about most is the returns they earn on their investments, this misses the point; one common factor in under-performance is high charging. A manager running a more expensive fund has to perform better than his cheaper counterparts just to match their after-charges returns.

It is this argument that has underpinned the rise and rise of passive management that we have seen in recent years. One reason active fund managers struggle to beat the market is they are held back by their charges; in which case, why not pay the lowest possible level of fees to a passive fund manager who will then get you closer to the index? Consistently good active fund managers should be able to counter this argument by pointing to a long-term record of outperformance either with their higher fees. Trouble is, there aren’t so many of these managers around.

We live in interesting times, however. Investment companies are often regarded as especially attractive during volatile markets, when the relative freedom of their managers offers certain advantages – greater flexibility on asset allocation and stock picking, for example. The next 12 months will be fascinating in this regard: not only are investment companies more competitively priced than ever before but they may also be in a strong position to deliver on performance in these market conditions.