The Investment Association (IA), the trade body that represents UK investment managers, has published research which finds that fees are not highly detrimental to investment funds' returns, but critics argue that the research is not comprehensive enough.
The IA and fund research company Fitz Partners analysed more than 1,300 equity funds, and found that transaction costs such as commissions and stamp duty between 2012 and 2015 were 0.17 per cent based on an average portfolio turnover rate of 40 per cent. With an average ongoing charges figure (OCF) of 1.42 per cent, costs amounted to 1.59 per cent. The OCF includes the management fee and costs such as fund administration, custody, audit and regulator fees.
These costs were then subtracted from benchmark index returns to establish the post-fee returns one would expect from funds, and these were compared with the average net returns of funds across numerous sectors. And it was found that funds outperformed markets, even when ongoing charges and explicit transaction costs of 1.59 per cent were counted.
"Funds on average performed better than markets they invest in by 0.71 per cent on an annualised basis," said the IA. "Across all equity sectors, most funds either outperformed their benchmarks or underperformed by far less than fees and transaction costs would indicate."
The effect of costs on equity funds
| Portfolio turnover rate (%) | Transaction costs (%) | OCF (%) | Fund return (%) | Benchmark return (%) | Realised outcome (%) | |
|---|---|---|---|---|---|---|
| 2012-2013 | 41.07 | 0.17 | 1.42 | 14.28 | 13.78 | 0.49 |
| 2013-2014 | 40.01 | 0.17 | 1.46 | 17.2 | 15.2 | 1.99 |
| 2014-2015 | 40.4 | 0.17 | 1.4 | 8.14 | 8.51 | -0.37 |
The research focused on funds' pre-Retail Distribution Review (RDR) share classes, which include bundled adviser and platform fees. These are typically the most expensive share classes because they include advice and distribution costs. Since RDR in 2012, fund share classes available to investors are generally cheaper because they do not include commission to financial advisers or platforms - you pay this separately on top. If you bought funds before 2012, it is likely that you will hold the older classes included in this survey.
"Post-RDR it should be possible to measure much more clearly fund manager delivery, which will help to inform the value for money debate and the results would be even better using the unbundled pricing of the new primary share classes," adds the IA.
However, Gina Miller, founding partner of wealth manager SCM Direct, says the report ignores market-maker spreads costs. "Transaction costs should include the spreads of securities, the bid/offer spread, but these have been ignored as the analysis just looks at those transaction costs reported within the fund accounts," she says.
However, the IA is launching a public consultation later this year on the delivery of a new Disclosure Code to achieve fully standardised reporting both of fees and charges, and implicit costs such as bid-offer spreads. It adds: "If implicit costs were significantly damaging investor returns, this would be seen in poor net return data - and our results indicate that this is not the case."
Laith Khalaf, senior analyst at Hargreaves Lansdown, says: "There is a genuine question over the correct presentation of transactional charges, because they are variable, and so an annual calculation may give a misleading impression of the regular costs to investors. Events such as manager changes and extreme fund flows can create spikes in turnover and transaction costs, despite being non-recurring by nature. Transaction charges are an important factor in returns, but most fund managers are rewarded based on their performance, so won't trade unless they believe it will be of benefit to investors."
Ms Miller also points out that the research only covers a three-year period, 2012 to 2015, and during this time mid-cap stocks performed well in most markets. In the UK, for example, the FTSE 250 massively outperformed the large-cap FTSE 100, so active funds which tend to be overweight in such companies performed well.
The IA maintains that the analysis offers strong empirical evidence of recent industry performance in the context of charges and transaction costs across a large sample of UK funds.
Ms Miller also says the report doesn't account for survivorship bias, whereby funds that perform well tend to grow whereas funds that perform badly get closed or merged into other funds, so disappear from the data for analysis.
