Why low cost funds are nothing new

Investors looking for low-cost solutions should not automatically go for the new semi-actively managed, open-ended funds, writes Charles Stanley's Stephen Peters.

Earlier this year, a number of fund management groups announced the launch of certain new open-ended funds. The funds were semi-actively managed, with low fees and no commission payable to advisers.

They were publicised as being ‘low-risk’ options for investors who chose funds more on the basis of cost than whether they are actively managed. This was in advance of what the managers saw as a change in investor demand after 2012.

Commentary in relation to these funds seemed to implicitly recognise the fund management industry had acknowledged that the excessive fees for sub-par performance put off many fund buyers. Adopting a low-cost passive approach to investment in these funds allowed managers to retain assets and associated fees, while meeting the changing needs of investors.

However, investors can already invest in vehicles that generally cost less than open-ended funds.

Analysis by the AIC last year found around one-third of the 251 investment trusts considered had TERs under 1%, and 58% under 1.5%. All except two of these are actively managed, and include some of the sector’s best-known names such as Scottish Mortgage or City Of London. And while the sector is getting slightly more expensive, this is a consequence of more specialist funds being launched in recent years.

Underlying costs

Lower underlying costs in running ITs has led to many charging lower fees than their open-ended equivalents. However, this has led to an inability for the sector to compete with open-ended funds as they are not able to fund large marketing campaigns. Investment trusts remain the preserve of the few – something the sector has always struggled to overcome. This surely goes to show fees are not the only determining factor for most individuals when looking to invest.

There has been an expectation in the industry for many years there will an ongoing separation in the demand for ‘beta’ and ‘alpha’ strategies. This is recognised by these new fund launches, but there is no lack of cheap ‘beta’ options to investors.

There are two passively managed ITs, many open-ended index-tracking funds and any number of ETFs that offer full index replication across a range of markets, full asset backing and little if any counterparty risk. And while not the topic of this article, the concept of investment risk as simply being deviation from a benchmark is surely a flawed one. We therefore question the need for yet more funds when what the industry really needs is better management of the ones we already have.