The recently published FCA interim report of its market study into the asset management industry has placed a flag into the sand that it believes that investors should be increasingly discerning about the level of fees they pay for services. As early as the fifth point in the study's executive summary, a chart details the potential impact of high active fees over a passive alternative to savers' wealth.
Indeed, advisers have had the obligation to consider fees for many years. In COBS 6, the FCA states that 'in order to meet its responsibilities under the client's best interests rule and Principle 6 (Customers' interests), a firm should consider whether the personal recommendation or any other related service is likely to be of value to the retail client when the total charges the retail client is likely to be required to pay are taken into account'. The market study has thrown the gauntlet down to the industry to come clean about the full costs that investors incur and to justify them. Declining prospective returns from investments are merely compounding the issue.
However, as the old saying goes, price is what you pay; value is what you get. Cost works hand in hand with value for money. For instance, in depth expensive credit research undertaken by bond investors may not appear cost effective during the majority of years but the ongoing analysis could prove to be invaluable when recessions eventually hit. What is the appropriate fee to be paid to fixed income on an annual basis?
When looking at equity funds, I believe that it is helpful to attempt to disaggregate performance generated by the market and that generated by the manager. To illustrate with an example, Fund A is targeting an outperformance of the market by 1.5% pa with an expected tracking error of 3%. Fund B has greater latitude to operate and has a tracking error of 6% but it has a greater outperformance target which is 3%. If both funds meet their performance targets, the funds will share the same information ratio of 0.5%. Fees on fund A are 70bps whereas fees on fund B are 90bps. Does this mean that Fund A represents better value for money than Fund B? Arguably not, since we can generate the returns by investing half the capital into Fund B and half into an index tracker which has fees of 10bps This would produce an instrument that generates the index return plus 1.5% at a cost of only 50bps.
There are of course factors to take into consideration. The assumption that the funds will meet their performance target seems particularly heroic. Even if confidence is high that they will, it matters under what circumstances the fund will meet these objectives. Investors have aversion to losses. Therefore, investors should have a preference for funds that outperform in down markets over those that perform best in up markets, even if the long term returns are the same. The full value for money offered can perhaps only be fully assessed qualitatively.
Square Mile have recently expanded their fund factsheets to incorporate a section on value for money. This section contains analysts views of why they believe that the fund represents value for money and also includes a chart detailing the fund cost in relation to its peers. The peer group is based around the appropriate IA sector but any anomalous funds that would distort the analysis have been removed, as have passive funds. The fee assessment is based upon the clean retail share classes and reflect the charges suffered by the typical fund buyer. The removal of passives may be somewhat contentious but we take the view that investors will wish to factor the potential benefit of active management, without the distortion created by an array of passive funds. Usually, it is only the lowest cost passive fund that is of interest to the investor and this can simply be considered as an alternative.
The chart details the Ballie Gifford High Income Bond fund versus its peers operating in the Sterling High Yield Bond sector. The fund (the black bar) immediately stands out as an attractive low cost option. Sub-investment grade bonds require a considerable amount of analysis, and the fact that this fund gives access to both an experienced team of managers and analysts and a well-defined process at such an attractive price should be appealing to many investors. This fund as a result represents excellent value for money.
We believe that displaying the information in the form of a chart is intuitively easy to interpret and imparts greater information than say simply recording its percentile ranking. We believe that this approach will prove helpful to fund selectors both in their analysis and providing evidence that value for money has been considered as part of their deliberations.
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