Managed funds fees are cutting returns

Investors can achieve significantly higher returns by switching to lower-cost funds.

Summary: High managed funds fees are eroding investor returns, and most funds are underperforming.

Key take-out: Investors can take greater control by comparing their fund, and switching to lower-cost alternatives.

 

Australian Securities & Investments Commission deputy chair Peter Kell wasn’t mincing his words last week when he spoke of the regulator moving to improve transparency around financial products.

Speaking at an event in Melbourne, Kell outlined how the regulator is taking a greater interest in the financial products supply chain, from design to distribution, to ensure the investment promises made to consumers are actually being delivered.

It’s this push towards greater transparency, around promises and outcomes, where Australia’s managed funds sector will likely have to improve its game around full fees disclosure. The Productivity Commission and the banking Royal Commission have both focused on the distinct lack of transparency in many areas of the financial industry.

In an industry managing $1.2 trillion of investors’ assets, it seems many retail investors are still being kept in the dark in terms of total fees being paid – from platform fees to investment management fees and other costs. Higher fees, of course, translate into lower investment returns.

Disturbingly, a large percentage of managed funds are still charging high fees and consistently underperforming against peer market benchmarks.

Research conducted by InvestSMART using data from investment research group Morningstar shows that, at May 2018, out of around 5,300 Australian managed funds that have a 10-year investment history, 76 per cent had underperformed their industry standard benchmark by an average of 1.75 per cent per annum.

What’s staggering is that there is currently around $330 billion of investors’ capital sitting in these underperforming funds alone, which are charging average fees of 1.73 per cent per annum.

While average management fees on some investment products have been falling in recent times, especially on index-tracking exchange-traded fund products, many investors in managed funds are often paying higher fees than those in other funds largely providing the same investment exposures.

Some investors are being hit with ongoing annual product management fees of 2 per cent or higher on managed fund products, equal to roughly a third of their total gross return. Often these are older-style managed fund products that have been superseded by newer products that provide the same investment exposures at a lower cost.

What’s worse is that the highest management fees being charged are by the actively managed investment funds whose primary mandate is to outperform against their market benchmark. In most cases, they haven’t.

Why have most managed funds underperformed? Just ask billionaire US investor Warren Buffett, who famously bet $US1 million in 2008 against the asset management firm Protégé Partners over whether a fund that invested purely in the S&P 500 Index could outperform five different actively managed funds.

Buffett’s 10-year wager paid off earlier this year, with the S&P 500 Index up more than 70 per cent compared with returns of less than half of that by the hedge funds chosen by Protégé that sought to outperform the index. They mostly underperformed because of their fees.

Put simply, most fund managers will underperform industry standard benchmarks over the long term by the cost of their fees.

Fees can be controlled

The most important dimension to the managed funds fees issue is investor apathy. Many Australian investors are paying the ultimate financial price by choosing to keep their capital in underperforming managed funds instead of shopping around for better alternatives.

While it’s impossible to predict the future performance of a particular fund, what most investors are ignoring is that the amount of fees they are paying can be controlled by switching into funds that, by virtue of charging lower management fees, will outperform their competitors. Some will outperform their set benchmarks in different years, but over longer periods they probably won’t.

But the key is to choose funds that offer the same or similar investment exposure, such as to Australian large cap or mid cap stocks, or to global markets, and that charge lower management fees.

The easiest way for investors to compare between different funds covering the same investment category is by matching one or more funds to the market benchmark they are measuring their performance against.

InvestSMART has just released an industry-first online tool, Compare Your Fund, which allows investors to compare the fees and performance of nearly 9,000 Australian investment funds.

The free to access tool can analyse the performance of managed funds, super funds and pension funds against peers and industry standard benchmarks, and also allows investors to assess fund fees against comparable funds.

InvestSMART’s funds research is telling. It show that 96 per cent of managed funds in the multisector moderate category have underperformed the benchmark Morningstar Aus Msec Moderate Total Return AUD comparison index over the last 10 years by an average of 1.54 per cent per annum, and are charging average annual fees of 1.58 per cent.

Similarly, 92 per cent of funds in the multisector growth category have underperformed the Morningstar Aus Msec Growth Total Return AUD comparison index over 10 years by an average of 1.62 per cent, and are charging average fees of 1.69 per cent.

The story doesn’t change across other fund categories, except that the total percentage of underperforming funds does reduce. For example, 56 per cent of those in the Equity Australia Large Blend fund category that track the S&P/ASX 200 Total Return AUD index underperformed over 10 years by an average of 0.74 per cent. But the average fees charged per annum are substantially higher at 1.05 per cent.

The performance and fees gap is even wider for those funds in the Equity Australia Real Estate category, which track the benchmark S&P/ASX 200 A-REIT Total Return index. Over 10 years 72 per cent of those funds underperformed by an average of 0.79 per cent, but on average charged 1.27 per cent in fees per annum.

It’s evident to most investors that the amount of fees paid will have a direct impact on returns over time. Yet this becomes even more stark when an investment is left in an underperforming fund over a long period of time.

A 1 per cent difference in management fees on a $50,000 investment in a fund returning 10 per cent per annum amounts to $167,000 over 30 years.

For investors, fees transparency is key, and it’s not always there.

In ETFs and listed investment companies, fees are invariably built into a security’s on-market trading price. In managed funds, they are easier to discern by virtue of a fund’s product disclosure statement.

But behind the scenes, the launch of new products, and the increasing use of index-style products, are putting greater pressure on fees.

The key message for investors is not to stay in underperforming managed funds. They are costing you better returns. Look around, and shop around.

 

Put your fund to the test. Take the managed fund challenge and compare your fund today.

 


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