As funds keep growing, are managers cashing in or reducing fees for investors?
Fund providers have been criticised for failing to pass on administrative cost savings as their mandates grow in size.
The underlying operating costs of running a fund should be fairly flat irrespective of assets under management, according to Morningstar director of fund analysis Thomas Lancereau.
He says: “Asset management is a very scalable business. There are costs that don’t change significantly with growing assets. Annual reports and similar elements are fixed, whether you run a fund that has £100,000 or £1m.”
In other words: it doesn’t cost significantly more to run a big fund than a small one. But as charges are set as a percentage of a fund’s assets, charging investors the same administrative fees can lead to greater profits as the fund scales.
That creates an opportunity for investment houses with large funds to reduce fees for investors. But how many are doing so?
Adding up the admin
M&G’s mammoth Optimal Income fund has £19.4bn in AUM – the second biggest in the Investment Association’s Sterling Strategic Bond sector.
Yet M&G levies a fixed administration charge of 0.15 per cent across all of its funds. The result is that investors foot a £27m bill for administration alone for Optimal Income.
The firm says these costs cover “items such as the maintenance of the share register” and “the distribution of income to customers”, and are levied on index funds as well, including its £499m Index Tracker fund – a passive option some 40 times smaller than Optimal Income.
M&G levies an additional 0.17 bps in “accounting, or audit” fees for the tracker fund, more than some actively managed funds that cover the UK All Companies sector.
An M&G spokeswoman says: “We are reviewing the design of our fund charging structure with a view to further simplifying it for our customers.”
Vanguard, which has two rival tracker funds with £8bn and £71m AUM retrospectively, charges its clients 0.08 per cent or 0.06 per cent as an ongoing charges figure for the funds, including administration and other expenses such as regulatory and audit costs.
Where the costs come from
The impact of additional fees for services like administration can hit on investors’ returns.
If you decided to invest £10,000 over three years in UK equities, say, and wanted a household name, you could have put your money in the Schroder MM UK Growth fund. You would now have £11,219.
Had you opted for Castlebay UK Equity, by Valu-Trac Investment, you would now have £11,391, according to Morningstar.
While this may not sound like huge variance, over a longer period and larger portfolios the difference can add up, and is partly down to administrative costs.
The Schroder MM UK Growth fund also charges 0.15 per cent for administration on the fund, to which some of the difference can be attributed.
Castlebay, however, lists zero “other expenses” outside of its OCF. By way of another comparison, if you started out with £10,000 in Invesco Perpetual’s Mark Barnett-managed behemoth £7.5bn High Income fund, you would be charged 0.91, with other expenses like administration rolled in.
Goliaths in the spotlight
The FCA has been increasingly scrutinising fund managers’ value for money, and firms will soon have to formally assess the value they are providing to clients. In its own assessment, the FCA questioned whether companies with operating margins sometimes as high as 45 per cent were offering the best possible value for money.
Under upcoming rules, companies will have to annually report on how they are running their funds – both in terms of breakdown of ongoing costs and whether these services are run in-house or outsourced by a third-party provider.
They will have to disclose individual funds’ costs and evaluate how are they implementing any savings – whether by cutting fees for the end client, reinvesting in the company or subsidising other parts of the business. They will, however, have to provide justification as to why they are not passing the discount on to their clients. In its asset management market study, the FCA focused mainly on the largest companies to review how economies of scale worked in practice.
Apart from large profits on sizeable funds, these companies can leverage their position in the value chain, where they outsource to third-party companies and negotiate discount deals, or reinvest in building in-house services, which could then in turn provide future savings on the total cost of running the funds.
Core items that fall under operating costs include administration, accounting, foreign exchange, securities lending, and collateral management, but can also include further fees at the discretion of the fund manager.
In the case of some funds, that may mean “director fees”, which then fund travel, hotel and other expenses incurred by the board in attending meetings.
Admin costs need action
One of the mysteries of the costs of funds is why they don’t get cheaper as they get bigger. After all, economies of scale are there in the operating expenses of the fund so in theory as the fund grows, the costs of running it should fall. This is what the FCA highlighted in its 2016 asset management study.
This is all based around the administration costs of running the fund where the fees charged for things like administration and custody are often done on a percentage basis that decreases as the fund grows. As a result, the operating expenses of the fund should become proportionately less as the fund grows. Some groups manage to negotiate a fixed cost for these services which, again, results in lower costs as the fund gets bigger. Some groups are very good at passing these lower costs on to investors, with Baillie Gifford being an excellent example. However, some groups do not seem to be so customer-friendly.
For example, M&G charges a fixed administration cost of 0.15 per cent for its funds, regardless of fund size. It begs the question, does it cost 10 times as much to run a fund that is £1bn compared to one that is £100m? The answer is of course: it doesn’t.
To me, there is absolutely no justification for fund groups not passing on the economies of scale.
If we use M&G Optimal Income as an example, it is £19.4bn in size, and therefore M&G charges £27m in admin costs for operating the fund.
If groups such as Baillie Gifford can typically have operating expenses of 2 basis points, why can’t others? It seems remarkable that M&G’s admin expenses are seven-and-a-half times higher than Baillie Gifford’s.
Ryan Hughes is head of active portfolios at AJ Bell
Pressure to pass on cost savings
While asset managers, and especially large ones, are under pressure to lower fees, some question whether efforts to do exactly that have been taken seriously.
When JP Morgan Asset Management recently introduced variable expense fees, it did not generate much response from the industry.
JP Morgan AM declined to comment on how it managed to find resources to fund the new fee structure, and what reaction it received.
Transparency Task Force director Andy Agathangelou says: “The financial sector as a whole is not understood by investors.
“They think the marketplace is complex, difficult to understand, opaque, and, because it is a very difficult marketplace, it is difficult for consumers to appreciate positive changes.
“What this helps us understand is how difficult it is for a message about cost, and the importance of cost, to get to consumers.
“It is as if they are unaware of how important costs are, and therefore are unaware how significant it is and how positive it is if there is a reduction in cost.”
By setting reporting standards, the FCA is hoping to compare how savvy different firms are when running similar funds.
Director, Shore Financial Planning
There should be economies of scale the larger a fund gets, however that rarely happens. That isn’t the same as saying a fund house should have to keep costs low.Ultimately investors can vote with their money if they think a fee is too high.
I do look at fees, however it isn’t my primary concern. I’m more interested in fund process, style, management and active share, to name a few things. Fees are clearly important and paying high active prices for closet trackers, for example, is an obvious area to watch out for.
New fee models in town
When trying to compare and contrast how asset managers charge investors for operating funds, the watchdog faced several obstacles, including variance between different companies’ business models.
Many companies cite simplicity and clarity as reasons behind their fee structures.
Close Brothers Asset Management introduced a single fixed fund management fee last year, in a move some said was aimed at addressing FCA concerns.
Similarly, Merian Global Investors charges its UK-domiciled funds’ investors a fixed ongoing charge and cites “predictability” for investors through introducing the structure.
The ongoing charge figure can slightly fluctuate year on year. Merian says that when the cost of running a fund overruns profits in that fund, it will pay the difference out of its own pocket.
However, if the profits are higher than what it actually costs to run the fund, it will retain the difference.
Orbis Investment Management does not charge investors in its UK-domiciled funds for operating costs. It can afford this by subsidising running funds from other parts of the business.
More AUM, lower charges?
Morningstar’s Lancereau says investors will benefit from more light being shed on how asset managers are using their resources when managing their money.
He says: “We don’t receive a bill when we buy into a fund. Sometimes fees are not properly documented. There is a need for higher transparency; fees should be broken down into what goes into management, compared with what goes into filing and marketing, and what goes into administration.”
He adds: “Some in the industry may argue that overall it is the expense ratio that matters at the end of the day. I disagree – firms that spend large portions of fees on filing and marketing and those that keep it for research may have very different prospects.
“Transparency of how the money is spent would help increase investors’ awareness.
“If you look at the due diligence required for asset managers, is it good? Management fees should be low. There should be scheduled fund points where fees go down as the fund reaches pre-determined asset levels.”
Lancereau also adds that downside protection would have to be in place in such fee schemes by setting up “safety net” breakpoints to protect investors in case the fund size was to shrink.