What's in my ongoing charge: cheap funds explained

What do you get for your ongoing charge?

The amount you pay for a fund varies enormously depending on the assets you want to hold and the way in which the fund house charges for the costs it incurs. All funds, regardless of whether you buy a closed or open-ended fund, apply an ongoing charge figure (OCF), which includes a mix of fixed and variable costs. 

The main things included in an OCF are a fund’s annual management fee (AMC) and another layer of variable costs such as trustee and auditor fees that are taken directly out of the fund. The AMC represents the fixed annual costs of running a fund and it averages 0.75 per cent in most actively managed funds. In the past, the AMC you paid to a fund house was higher, at an average 1.5 per cent, and it included a commission to the fund supermarket you used to buy the fund or the financial adviser you used. But in 2014, the Retail Distribution Review (RDR) unbundled those commissions and now you pay a separate fee to the fund, the financial adviser and the fund supermarket.

The OCF varies between fund and fund house depending on what costs the fund house decides to charge to the customer and the assets and markets that the fund is exposed to.

Risky assets cost the most

Funds generally levy a higher AMC for riskier and more volatile assets. The most illiquid assets to buy and the most under-researched or niche markets are the most expensive to invest in via funds, while the most popular and well-known markets with the most fund choice are the cheapest.

The most expensive open-ended funds to buy include those grouped in the Investment Association (IA) Chinese and Greater Chinese equity sector, due to the restricted nature of the Chinese equity market. Funds in this sector average an OCF of 1.54 per cent.

The most expensive investment trusts are property funds. Asian and European property are the most expensive sectors, with average OCFs of 6.56 per cent and 2.04 per cent respectively, (including a performance fee – a fee awarded to closed-ended fund managers for beating a certain hurdle). Funds in the specialist property and direct property sectors are also expensive on a relative basis.

Research and due diligence costs are higher for niche markets and small-cap equities than large-cap stocks and developed markets such as the US. These require less monitoring and research and are more efficient markets that require less work on behalf of the fund manager.

The cheapest funds in the Investment Association on average are short-term money market funds, with an ongoing charge of 0.24 per cent, and money market funds, with an average OCF of 0.26 per cent. UK index-linked gilts, UK gilts and sterling corporate bonds are also cheap to hold via open-ended funds.

Money market funds invest in highly liquid, cash-like assets and are designed to provide investors with a low-risk, low-return investment. "The margins on cash-like products are fairly tight,” says Adrian Lowcock, investment director at Architas, "which explains why money market open-ended funds are cheap. The gilt and bond market is also fairly efficient, so research and analysis costs are not necessarily as high.

"Much of [bond fund research] is driven by computer programmes that crunch the numbers whereas equity analysis requires more comprehensive research including meeting the management (although bond fund managers can do that too) and getting to understand the growth potential and income needs of the business," he says.

"Equities need constant reassessment and monitoring, whereas bonds are often more frequently monitored using price or yield markers."

The cheapest closed-ended funds are those grouped in the AIC Global sector, with an average fee of 0.65 per cent inclusive of performance fee, and UK All Companies trusts, with an average OCF and performance fee of 0.7 per cent. UK Equity Income, Global Equity Income and UK Smaller Companies funds are the cheapest investment trusts to buy, all costing under 1 per cent including OCF and performance fee.  

The OCF does not include all costs you experience as an investor, though. Some costs not included in that figure include transaction and dealing fees incurred by a manager when they buy and sell holdings. Those fees are also higher for higher risk and less liquid markets.

Illiquid assets such as property are pricier because they are harder to buy and sell and the trading costs associated with them are higher. It also explains why assets such as small cap-equities are also pricier to invest in than large-cap UK stocks.

"If you are buying shares, a market maker is taking on risk to do so and charging you a bid/offer spread," says Darius McDermott, managing director of Chelsea Financial Services. “The spread is greater on a small-cap equity than on a large share such as Vodafone," he adds.

"Markets such as emerging markets and Asian markets also have larger spreads and those costs of investing are passed onto the customer."

"The more expensive funds are relatively niche types focusing on frontier markets, single countries or single strategies such as pharma or robotics, for example," says Mr Lowcock.

"Those markets are smaller universes of stocks and research and access to the market is more expensive. There also needs to be a bit more risk assessment around them so more work has to be done by the fund around controlling and assessing the risk to the fund," he says.

Buy through platforms for lower OCFs

The OCF you pay also depends on the platform you use to buy your investment. Platforms are able to negotiate lower fees with asset management companies due to the volume of assets on their books. For example, the average cost of an open-ended fund on Hargreaves Lansdown is 0.85 per cent compared with 0.98 for the average open-ended fund.

The average Asia ex Japan fund costs 1 per cent on Hargreaves, 0.09 per cent cheaper than the cost of an average Asia ex Japan fund not bought through the platform according to Trustnet. Specialist trusts cost 1.3 per cent on the open market but an average of 1.17 per cent when bought through Hargreaves Landown.

Different platforms will levy different savings on your fund fees and so it makes sense to take a look at the savings you could be making with other platforms.

Different fund house, different fees

Asset managers differ in the fees they choose to charge to investors through funds and those that they choose to charge to the company balance sheet. One of those includes research fees.

Recently, Woodford Investment Management and Hermes Investment Management stopped passing research costs onto clients. Those costs include paid-for reports from economists and strategies and the cost of face-to-face meetings and telephone conversations.

Since April 2016 Woodford Investment Management has absorbed those costs. In February 2017 Jupiter announced it would pay research costs and in July 2017 Hermes also announced its intention to do so.

Mr McDermott says fund houses should do more to cut those costs. He says: “Funds could improve things by taking more costs onto their own profit and loss account as opposed to charging them to funds.”

The cheapest type of fund

Following the Retail Distribution Review (RDR) in 2014, investment trusts and open-ended funds are often not dissimilar in price. In the past investment trusts were generally thought to be cheaper than open-ended funds but that gap has narrowed.

The average ongoing charge of an investment trust, according to the AIC, is 1.14 per cent, and 1.24 per cent including performance fee. The average cost of an open-ended fund, according to Trustnet, is 0.98 per cent. However Morningstar puts that figure at 1.26 per cent because it strips out a range of small categories including Japanese smaller companies and technology and telecoms, which it says distorts the overall picture.

The most expensive of all funds are closed-ended funds, with  a much higher OCF at over 6 percentage points more than the most expensive open-ended fund. The cheapest of all funds are also open-ended funds – short-term money market funds average 0.24 per cent, cheaper than the cheapest closed-end category, at 0.64 per cent.

Tracker funds and exchange traded funds (ETFs) generally remain the cheapest option (because they are not designed to beat market benchmarks in the same way as active fund managers should, and do not have the same level of research, expertise and analysis going into their day-to-day management).

Average fund fees by fund type (%)

Source: the AIC, Trustnet & Hargreaves Lansdown

Most and least expensive open-ended funds by IA sector (average OCF %)

Source: The AIC

Most and least expensive average closed-ended funds by AIC sector (average OCF %)

Source: Trustnet