The silent thief: How costs are robbing you of returns

 
Sean Hagerty
Fighting at Gothenberg EU Summit
The silent thief: higher fees don’t always equal stronger performance (Source: Getty)

We are conditioned to think that if we pay more, we get more. It’s a behaviour that companies in all industries rely on because it encourages us to opt for more expensive options. And in most industries, it’s a logical choice.

But in investing it’s different. Here, what the product is trying to deliver – a performance target – is directly and adversely affected by the cost of the product. This is because every pound you pay in charges is a pound out of your future returns.

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You can think of costs as a hurdle between you and your investing goals. The higher the hurdle, all things being equal, the slower your progress will be. What’s more, just like investment gains, the impact of costs compounds over time, creating a real drag on investment returns.

Pay more, get less

Of course, higher-cost managers claim that you’re paying for superior talent – that your higher fees will be rewarded with stronger performance. It’s an attractive argument, but the data suggest this is not always the case.

The graph below shows global equity funds available to UK investors, with the funds’ relative performance against their stated benchmarks on the vertical axis and their costs, represented by the ongoing charges figure (OCF), on the horizontal axis. If the dot is above the line the fund has outperformed its benchmark, but if it’s below, it’s underperformed. And if the dot is to the right of the chart the fund has high fees, while those to the left have low fees.

There’s quite a spread of results, but the red trend line slopes downwards. In other words, on average, lower-cost funds provided better results versus their benchmark than their higher-cost counterparts. This chart contains active funds (in green) and passive funds (of which there are far fewer, in dark green) and the result holds across both approaches.

It also holds across different types of investments. We ran the same data across 11 different types of equity and bond funds available in the UK and the trend line sloped downwards in 10 of them. In the other, it was essentially flat. This shows that, in a broad range of markets, investors get better results if they choose lower-cost funds. To put it another way, in investing you get what you don’t pay for.

The quest for cost transparency

The good news for investors is that the Financial Conduct Authority (FCA), which regulates the financial services industry in the UK, is increasingly focusing on value for money and the impact of costs. In a recent report, it stated that costs and operating margins were high for an industry with the competitive structure that fund management has in the UK. It also stated that retail investors had poor appreciation of fund charges.

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Our own research echoes this finding. We found that almost a third of investors believed they weren’t paying any ongoing fund charges or didn’t know whether they were or not. Among younger investors the figure was even higher, at nearly half.

Closing the savings gap

This uncertainty has important consequences. It breeds a lack of confidence and trust, which in turn prevents people investing, creating a savings gap that is threatening the long-term financial wellbeing of the UK population.

To close this gap, the industry needs to do more to drive the cost of investing down, and to explain clearly what investors are paying and how those charges impact long-term returns.

At the very least, fund providers should give the same prominence to costs (which have a demonstrable influence on future returns) as they do to past performance (whose predictive power is much lower).

Health warning

In fact, in our response to the FCA we’ve gone as far as suggesting that all funds should carry a health warning along these lines: warning, check how much you are paying – high fees will harm your long-term returns.

We also think there’s an opportunity to design a rating system to make it easier for investors to understand the relative cost of a fund. We recognise that there can be limitations in ratings systems, but other industries have been successful in introducing indicative red/amber/green rating badges. And we don’t believe there is anything so particular about the fund management industry that would prevent this being possible for us too.

Others in the industry will have their own ideas about how best to ensure that investors receive value for money. But, if we’re serious about the long-term interests of investors, the whole industry needs to collaborate to ensure that investors receive value for money and the best chance of investment success.

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