Passive funds losing cost edge

October 4, 2013 6:27 pm

Passive funds losing cost edge

By Elaine Moore

Passive funds that allow investors to track the performance of worldwide stock markets are starting to lose their competitive edge on prices as providers of actively managed funds cut their fees. In spite of ultra-low annual fees offered by the largest providers of passive funds such as Vanguard, Legal & General Investments and HSBC, research by Morningstar has found that on average, retail equity index funds have a total expense ratio of 0.73 per cent.By comparison Investec Asset Management’s new “clean” share classes for six of its most popular actively managed funds, including the £2.7bn Cautious Managed fund, come with an annual management charge of 0.65 per cent. The clean price excludes the commissions that used to be automatically included in fund fees.

Passive investment in index tracker funds or exchange traded products has traditionally been favoured by investors who want to keep costs low. It has beengaining popularity as private investors lose faith with the idea that active managers can consistently outperform the market.

The Investment Management Association reported in September that tracker funds now accounted for 9.6 per cent of total funds under management by unit trusts – a larger proportion than ever before.

As assets held in passive funds grow, large providers have cut fees to less than 20 basis points (0.2 per cent), making the investments even more attractive.

But not all index tracker funds cost so little. Halifax and Virgin both charge a 1 per cent management fee for their UK FTSE All Share tracker and UK Index Tracking Trust funds, respectively.

Graeme Tones at Virgin said that fund costs were often linked to scale. “Smaller investments are costlier to administer and we have opened up the market to a host of people who previously would have been excluded from investing in the stock market,” he said. “The companies offering cheaper trackers invariably do so because they are charging much more on their other funds. We pride ourselves on offering all our customers value for money.”

Philippa Gee, a wealth manager, said that there was little to explain the higher cost other than a brand name. “Now that it’s clear how much money investors pay to advisers and providers there is more focus on value for money, but certain funds with a particular brand name can get still away with charging more,” she said. “These funds, and the multi-asset funds that combine passive and active management, are distorting up the average TER [total expense ratio] for trackers. Really, if you want a fund tracking a major index you shouldn’t be paying more than 0.3 per cent in fees.”

Prices are under pressure across the entire fund management industry, according to Danny Cox at Hargreaves Lansdown. “It’s hard to see how much further tracker fund fees can fall, but those charging 0.5 per cent might come down. There’s nothing in these funds that reflects why they might be more expensive.”

High fees reduce the net return that investors receive and can have a significant impact on performance over long periods of time.

However, advisers say investors should remember to look beyond costs when considering investment in passive funds including the index that is being tracked, and the way that the funds invest. Some passive funds opt to hold more in the largest companies in an index, while others will invest across all the companies. The differences can lead to a variety of tracking errors, meaning that a fund will not always mirror the index it is supposed to replicate.

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A confusion of charges

For all the talk of transparency and factory gate pricing, trying to work out what investing in a fund will cost can still be a frustrating experience, writes Elaine Moore.

Annual management charges (AMCs) may look eye-catchingly competitive, but they aren’t the only fees that investors pay. Extra costs, such as account dealing fees and stamp duty, push up the price, dragging down the eventual performance of
a fund.

As well as AMCs, some providers advertise the total expense ratio, which includes account dealing costs and stamp duty, but excludes trading costs.

New rules from Europe mean that open-ended funds must provide an “ongoing charges” figure, but this does not include performance fees or stamp duty.

Vanguard’s FTSE tracker, for instance, makes no distinction between its AMC and TER, which is 0.15 per cent. Fidelity’s Money Builder UK Index fund advertises “standard costs” of 0.1 per cent but “costs” of 0.3 per cent once service charges and fees are added.

Last year, HSBC opted to cut the annual management charge on its “clean” share classes. The AMC for its FTSE 100 UK Index fund fell to 0.1 per cent, but on top of this investors will pay a registration charge and dealing costs that push the price up to 0.27 per cent, plus a fee of 0.39 per cent if the fund is bought directly.