Last month the former chief executive of stock broker Collins Stewart, Terry Smith, launched a new fund company which he argued had a key difference: lower charges on active funds. However, Mr Smith has not been alone in launching such propositions this year.
In October hedge fund manager Crispin Odey launched an onshore version of his wealth management business which will charge a flat fee of 1 per cent – well below the average fee for an actively managed open-ended fund such as a unit trust or open-ended investment company (Oeic). Other recent low-cost launches include the Skandia Shield Fund, WAY Freestyle Growth, Absolute Return and Asian Spice funds, and TCF Total Clarity Funds.
Passive pressure
The whole reason for the discussion of fund fees and the sudden interest in launching lower-cost active funds has in part been prompted by the proliferation of lower-cost passive funds such as index trackers and exchange-traded funds (ETFs). These funds are much cheaper to run because they do not have managers and investment teams picking stocks and their total expense ratios (TERs) are usually below 1 per cent, in contrast to active equity funds which have average TERs of around 1.66 per cent. The TER consists of the manager's annual charge and the costs of services paid for by the fund, such as auditors' fees.
Passive funds have also delivered better returns than some active funds as their lower fees eat less of the gains, and many active fund managers have failed to outperform their indices, meaning trackers do better. For this reason, passive funds are becoming more popular: Barclays Stockbrokers reported last month that since September 2008 the value of ETFs held in its client accounts has risen 330 per cent, and the number of client accounts holding ETFs has more than doubled, a continuing trend.
The Investment Management Association, the trade body for the UK funds industry, reported in November that tracker funds achieved their highest year-to-date net retail sales since 2002, totalling £599m.
Not all funds are the same
The final outcome of the Retail Distribution Review has yet to be decided (see below), but there are concerns that IFAs could still bypass investment trusts on the grounds that they are too risky for some clients.
Also, while average TERs could drop, it may not be possible for all kinds of funds to be as cheap. Terry Smith's new fund, for example, which does not have an initial charge and stipulates an annual fee of only 1 per cent a year, invests in a few high-quality developed market equities which it will not trade frequently. "The Fundsmith Equity Fund is ideal as a core holding," says Mr Smith.
He will not include small-caps in his fund and is unlikely to buy emerging markets equities.
More esoteric or less liquid assets such as physical property can be more expensive to invest in, while funds of funds have to charge more because their costs include the fees of the underlying funds. But Christopher Traulsen, director of fund research for Europe and Asia at fund information company Morningstar, adds that costs such as trading and buying assets are not included in the TER, so there is still scope for funds investing in more unusual assets to lower their fees.
Can higher fees be justified?
Tom Stevenson, investment director at Fidelity, argues that it is not fair to compare active and passive funds. "Don't focus on cost, focus on value," he says. "Research is needed for a good bottom-up stock-picking fund and this is more expensive. The question is rather, does an active fund add enough outperformance of its index to warrant higher charges? Comparisons of the average cost of an active fund versus a passive fund ignore how much an individual active fund may have risen."
Mr Traulsen agrees that if performance can overcome the fees or the manager of a fund is clearly better than many others, it can justify higher fees, as these are only one of many factors to consider when choosing a fund.
