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On a road to nowhere?

A lot of time and marketing have gone into pushing absolute return and total return vehicles over recent years and now is the time for them to prove their worth but they have been somewhat hit and miss.

For this erratic performance, the industry has paid an ever rising cost for actively managed funds.

As funds have gained the ability to diversify outside mainstream asset classes to include areas such as derivatives, gold, exchange traded funds and so on, their construction has not only become more complex but more expensive.

In the past, the fund management industry has been happy to point out to the heavily criticised life industry that its charges are clear, transparent and fairly consistent across the board. These days, however, this does not seem to be necessarily true.

Lipper data shows that total expense ratios for actively managed equity funds have risen over the past seven years. The simple average TER for actively managed equity funds across all sectors has moved from 1.34 per cent in 2000 to 1.45 per cent in 2006. For the more mainstream sectors, the average has risen from 1.51 to 1.59 per cent, having peaked at 1.64 per cent in 2003. But while TERs may have moved up and then down again, Lipper data shows that the average management fee has increased year on year over the same time from 1.33 per cent in 2000 to 1.45 per cent in 2006.

Ed Moisson, director of European fiduciary operations at Lipper, says: “The market continues to tolerate fee rises in an almost self-perpetuating cycle.”

The group’s UK trends report says the reasons given for rising costs include bringing fees in line with similar funds in the sector and ending an historic anomaly. Moisson says: “On this rationale, as long as the average management fee for actively managed equity funds is below the median, then management fees will continue to rise. Of course, this is not just a question of existing funds pushing up their management fees but also new funds tending to set their fees at or just above the average. In this way, I would not say that average fee rises are purely a result of specialist funds.”

The more esoteric the market or fund, however, the more on the surface it does appear to cost. More recent data from Lipper shows that annual management fees average 1.44 per cent in the massive UK all companies sector, where you would expect the number of low-cost trackers with sub-50-basis-point AMCs would draw down the average. This compares with the average fee in the tech & telecoms of 1.56 per cent while 1.53 per cent is the average for the global emerging markets sector.

The data from S&P Morningstar is not a lot different. It suggests that the highest average AMCs are found in the Investment Management Association’s Asia Pacific ex Japan and North American smaller companies sectors at 1.53 and 1.5 per cent respectively.

With the exception of the UK other bond sector, all the fixed-interest categories feature average AMCs of less than 1 per cent.

This would appear to be a good thing for bonds and shows the added expense of equity funds but it does not reveal the entire picture. Funds Library information shows the huge variances not only in performance but TER and AMC levels.

Looking only at those portfolios with the marketing description of “strategic”, all of which are in the UK other bond sector, Funds Library data shows that initial charges on 10 portfolios with this moniker range from 3.25 to 5.25 per cent. There is a little more uniformity seen in AMCs, which range between 1 and 1.25 per cent.

The biggest differences come when examining the TERs. The portfolio with the smallest TER, according to Funds Library data, is Cazenove strategic at 0.72 per cent, which is actually lower than its 1 per cent AMC. The highest TER among this peer group of 10 strategic funds is 1.4 per cent on the Scottish Widows strategic portfolio, which features one of the lowest initial charges at 3.5 per cent.

Performance on these funds does not help the investor to draw many conclusions, either, with the overall most expensive fund based on TER, Scottish Widows, featuring the biggest drop over the six months to September 13 at -3.46 per cent. Meanwhile, the portfolio with the lowest TER, Cazenove, has the secondbest gain of the 10 funds at 0.02 per cent. The old adage that you get what you pay for does not appear to apply to the fund industry.

There is probably an obvious explanation for the discrepancies, for example, the different ways TERs are calculated and what they include. Of course, that argument does not make it any easier for advisers or their clients to see what they are getting when they are selecting a fund.

David Ferguson, chief executive of platform Nucleus, says there are many different ways to calculate TERs, making comparisons tricky.

Moisson says paying more for getting more is certainly a compelling argument and points out that the introduction of performance fees addresses this to a degree. He says: “The backdrop of hedge funds charging noticeably higher fees than long-only funds offers the means to justify higher fees for generating alpha.”

He point outs that price competition in Europe has been pushing down fees on passively managed funds while actively managed funds continue to increase their management fees. “I think it is worth asking whether one can separate alpha from beta generated by one portfolio and pay different fees for each,” says Moisson.

Ferguson says he is noticing that advisers are getting choosier on what they will pay for, either negotiating down costs or constructing client portfolios using more low-cost trackers and ETF-type vehicles.

He notes that Nucleus’s mix of trackers, ETFs, institutional funds and investment trusts – the no-load products – account for some 35 per cent of volumes at the moment, highlighting the growing attention intermediaries are paying to costs.

The knock-on impact of this trend, says Ferguson, will be greater pressure on groups to prove they are actually adding value for money, which could result in fund closures, which he says is no bad thing.

“The concept of lazy, high-margin money should become less relevant,” he says.


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