Funds with large price tags tend to perform worse net of fees than cheaper alternatives, according to new research that challenges the argument that active management is worth paying a premium for.
The study of 1,970 active funds by investor rights campaign group Better Finance will boost advocates of a radical overhaul of the asset management market. Active stockpickers continue to charge high fees for their services, which they justify by saying investors need to shell out if they want to beat the market.
But Better Finance’s analysis of funds’ net-of-fee returns over the 10 years to 2017 suggests that the opposite is true, finding a negative correlation between fund returns and fees. The study, which looked at equity funds based in Luxembourg, France and Belgium, calculated that by increasing a fund’s fees by 100 basis points, or 1 percentage point, performance in excess of the benchmark — otherwise known as alpha — falls by 68bp.
“Fees are nearly single-handedly to blame for the disappointing returns of many actively managed funds,” said Guillaume Prache, managing director of Better Finance.
Better Finance blamed the trend on fund managers’ “exploitation” of unsophisticated retail investors. Managers with poorly performing funds on their books are prompted by competitive pressures to intensify their marketing efforts and target retail savers, whose “insensitivity to performance can be exploited by charging higher fees”, it said.
The investor rights group said the rise of passively managed funds, which charge significantly lower fees, had had a positive influence on how active mutual funds were priced.
The Better Finance analysis will add weight to the argument that investors are better off investing in passive funds or buying equities directly.
Mr Prache said: “Selecting a fund is a fundamental decision for an individual investor. Unfortunately, our research clearly shows that … the average investor only had a 1 to 3.7 [per cent] chance of choosing an equity fund that would [outperform] its benchmark on any five-year holding period.”
The chance of picking a market-beating fund over 10 years was just 0.11 per cent, Better Finance found.
“Low-cost equity index funds or directly held diversified portfolios of equities are a valuable alternative option that should be offered to individual investors,” said Mr Prache.
Regulators across the world are alert to the high cost of funds and how this affects performance, particularly as governments seek to encourage more retail investors to invest in capital markets. A landmark report released by the European Securities and Markets Authority, the pan-EU regulator, this year found that retail fund investors lose up to a quarter of their gross returns in costs and charges.
Meanwhile, the UK Financial Conduct Authority’s scathing report into value for money in the asset management industry prompted it to introduce rules, such as requiring managers to carry out annual assessments of the value provided by their funds.
Some active managers have reacted to the fee scrutiny by shaking up their pricing models in a way that aligns investor and manager interests. Fund houses including Fidelity International and Allianz Global Investors launched funds with low annual management charges and take a fee only if their funds outperform, although the products have so far failed to gain significant traction.
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