Are retail funds worth the money?

TCF Investment CEO David Norman investigates why retail funds seem to leak money and explains how investors can get good value.

In most walks of life the more you buy of a product the cheaper it becomes per unit. Buy one battery and it costs a £1, buy a pack of four and they are 80p each, buy 10 and they are 50p each and so on. There is one rather notable exception to this – retail fund management.

Over the last 12 years retail funds under management have grown from around £200bn to over £500bn. Now you would have thought that with massive growth, coupled with the fact that there are pretty much the same number of actual funds in existence now as they was 10 years ago, that costs might have fallen.

After all it does not cost twice as much to run a fund which is twice the size. It is perhaps odd then that average TERs in the UK have actually risen over this 12 year period from around 1.5% per annum to closer to 1.7% per annum (source: Lipper). Advice fees have played a part in this but then the number of customers advisers are looking after has grown significantly.

International comparisons

Looking overseas it is interesting to note that, according to Morningstar, median TERs fall as funds grow in size in France, Germany and the US, but remain stubbornly flat in the UK. It cannot cost the same to run a fund of £100m as it does to run a fund of £1bn?

2010 median TERs based on various fund sizes (%pa):

 _{Source: Morningstar, 2010}

Morningstar provided data from the four largest fund jurisdictions in the world representing over $15.2trn of assets (source: EFAMA as at 30 September 2009).  The data was based on fund values and TERs as at 8 January 2010.

Shareholder value

The growth in retail assets has also created a significant rise in the shareholder value of these assets. As fund sizes grow, costs reduce and profit margin rises. As the number of customers (investors) rises so the diversity of revenue increases (less risk).

If we assume a profit margin on 0.3% per annum and a market multiple of 14 times then £200bn of retail assets would have total shareholder value of £8.4bn. That figure has risen over the last 12 years and now stands at over £20bn. Or put it another way about £400,000 of shareholder value per £10m of assets. This is consistent with the valuation of Jupiter when it floated at around £750m with £19bn of assets.

Advisers might be wondering who owns this value, and perhaps feel more than a little aggrieved that after all the hard work in building these assets, in finding the clients, in looking after the customers in the good times and the less good times, that they own none of this value. Fund managers pocket the lot.

You can certainly see why there is a focus on assets under management as opposed to assets under advice!