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Where is the UK fund economy of scale?

Dan Norman, CEO of TCF Investment, questions why UK fund management companies are not passing on to investors the reduction in costs they get when funds increase in size

Why don’t UK investment funds get cheaper as they get bigger?

Back in Economics 101, we all learned about economies of scale. It was one of those economic principles that made total sense. Assuming a business has fixed costs, as it gets bigger, those costs are spread ever more thinly, which reduces the costs per unit.

But despite a very large proportion of their costs being fixed, investment funds in the UK act as if they never attended economics class.

As their funds have grown significantly in size, their charges have gone up. Far from being just an academic failure, this reversal of the rules has failed investors and failed them badly.

Unlike investment funds in other countries, UK funds have been getting steadily more expensive for investors as they have increased in size. These apparent diseconomies of scale have shown up in the latest annual survey carried out by the sector’s own trade body, the Investment Management Association and analysis from TCF Investment.

Despite the average fund size and total assets under management more than doubling over the last decade, the average total expense ratios on UK funds have increased by nearly 10 per cent.

The IMA 2011 Survey – based on data up to December 2010 – showed that over the last 10 years, the average (mean) fund size has more than doubled, from £126.5m to £278.8m, as have total assets which have grown from £260bn to £590bn.

On the basis that the number of funds has been pretty much constant over this period, one would expect the costs per fund to go down as a percentage. There should be significant economies of scale as no more fund management resource is required, no matter how big the funds are.

But data from Lipper FMI shows that over the same period – when fund size and total assets more than doubled – average UK TERs had risen from 1.55 per cent a year to 1.7 per cent a year, an increase of nearly 10 per cent.

Put another way, the IMA data means the average fee per fund going to the manager has also more than doubled, increasing from £1.96m to £4.74m over the last 10 years.

The table here is the result of earlier research from TCF Investment on equity funds shows that the fund fees in many countries reduce as funds grow in size – but not in the UK.

Even though Germany has fewer big funds than the UK, managers pass more of the benefits of scale on to investors than happens in this country. On average, a £700m fund in Germany charges its investors £2m per year less than its equivalent in the UK.

A better way forward
In these times of high investment volatility and lower investment returns and interest rates, fund managers owe it to their investors and their advisers to do all they can to increase their efficiency and tighten their own, no doubt, expensive belts.

The very least they can do is stop taking advantage of the opacity of funds and their charging structures to hide rising fees and instead hand over the benefits of economies of scale to the very people who gave them the money to create that scale in the first place.

Making the advantages of size and scale to fund economics clear, transparent and of benefit to investors is very easy to achieve, even if extremely rare. It could be addressed by introducing a downward sliding scale of fees based on fund size, just as we do at TCF Investment.

Advisers themselves can do much to help achieve this sensible and just change in practice by seeking out funds that operate reducing fees with scale. And if their favourite fund managers do not offer their customers this basic measure of value for money and shared benefit, ask them why not.

Like too many other aspects of how the UK investment industry has been allowed to develop – where too often the net result is a well-paid manager whatever the outcome for he investor – this “anomaly” must be addressed if we can ever seriously expect investors to trust us. Now wouldn’t that be something?


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