Fee-thinking: price-check in the fund aisle
Article written by InvestNow – 29th October 2021
Nothing comes for free in this world, but price isn’t everything.
Indeed, while most people are cost-conscious (otherwise supermarkets wouldn’t run ‘special offers’), they are also usually prepared to pay more for perceived quality or ‘value’.
But for managed fund investors the concept of ‘value for money’ – now a major focus for the Financial Markets Authority (FMA) – might be harder to discern than a two-for-one deal on frozen pizzas at Countdown.
In its recently published guidance on ‘Managed fund fees and value for money’, the FMA attempts to nail down the price of investing to a few principles involving scale, service as well as the important – if not widely understood – balance between risk and return.
“Greater transparency about fees and value for money will enable scheme members to make more informed decisions about who they invest with,” the FMA guide says. “It will enable broader scrutiny and commentary from the media, consumer advocates, political stakeholders, and the public, which will help to inform members’ investment decisions.”
Behind the bundle: multiple costs in single sticker
Like many financial products – see mortgages, term deposits and credit cards, for example – managed funds are invariably priced in percentage terms.
The per cent price refers to a proportion of fund assets under management at a given time. Typically, funds accrue the percentage fees in the daily unit price with actual cash payments transferred to the manager on a regular basis – monthly, for instance.
In many cases, but not all, the so-called ‘sticker’ price bundles most of the fund costs into that single number, which covers among other items:
- investment management – ie the various duties involved in investing such as security selection (manager expertise), research, trading, technology and other mundane business expenses;
- administration – systems that accurately implement and track investment orders and member information; often outsourced to external providers;
- supervisor – all regulated funds require a third-party licensed supervisor (previously known as a trustee) to ensure they follow investment and governance guidelines;
- custody – the legal ownership of fund assets; independent custodians (InvestNow uses Adminis for the service) keep member assets at a distance from the manager and make sure investment decisions are implemented efficiently and as per fund rules.
All-in (and off-label)
The majority of managed funds issued in NZ today publish both the single all-in fee as well as a breakdown of some of the underlying cost components in the fund Product Disclosure Statement (PDS).
Furthermore, the fund PDS should also clearly state any other potential fees, or costs, that fall outside the sticker price with examples including ‘individual action’ charges such as fixed dollar entry-and-exit or contribution fees.
Many KiwiSaver schemes also continue to charge member fees (usually expressed in monthly or annual dollar terms): although the practice is dying out, led by InvestNow with the InvestNow KiwiSaver Scheme, which was the first KiwiSaver to launch without fixed dollar member fees.
Outside of KiwiSaver, member fees are highly unusual but at least one provider, Simplicity, does include a fixed dollar annual charge for investing in its retail funds.
Sometimes financial advice fees are also incorporated as part of the management fee, especially in KiwiSaver schemes, while other funds allow adviser charges to be added on to individual accounts.
The difference is critical: embedded advice fees essentially distribute the cost across all fund investors whether they use an adviser or not; while individualised fees attribute the expense to investors who actually seek advice.
Even the regulator is in two minds about how to resolve the fund advice fee issue.
According to the recent FMA guidance, the regulator wants to “avoid a situation where fees for advice are embedded within broader fees paid by all members, are not transparent to members, and result in schemes competing to make offers to advisers to ‘buy’ members from them”.
“We prefer that fees for advice are charged to the member, not the scheme, or are otherwise structured so members can choose not to pay the fee,” the FMA says. “We acknowledge, however, that the KiwiSaver market is still maturing – balances tend to be lower than for other managed funds, and even a moderate, optional fee for advice may dissuade KiwiSaver members from using or seeking it.”
And investors need to watch out for two other common expense categories: performance fees; and, buy-sell spreads (see our article – “Spreads – Why they’re fair”).
Some managers charge performance fees over-and-above the standard fund sticker price if their investment returns beat a pre-set benchmark level over a certain time period.
Again, performance fees are relatively rare in NZ retail funds, but they are used by a few local managers on the InvestNow platform – notably Milford Asset Management and Fisher Funds.
Performance fees can be complex and investors should read disclosure material carefully to understand how each manager justifies and implements them.
Buy-sell spreads, meanwhile, apply to investors as they enter and exit funds (importantly, these are different than fixed dollar ‘individual action’ fees): under the process, investors will pay slightly above the current unit price for buying into a fund and receive a little below the unit price for selling.
The rationale for buy-sell spreads centres on the trading costs imposed on funds as investors choose to move their money in or out (see what AMP Capital, Harbour Asset Management and Russell Investments have said on the topic).
Buy-sell spreads are sometimes portrayed as an unnecessary charge but, according to InvestNow General Manager, Mike Heath, the practice actually ensures all fund investors are treated equitably over time.
“Without buy-sell spreads, investors who remain in the funds end up subsidising the trading costs of those coming in or leaving through receiving lower returns,” Heath said. “Not all NZ funds include buy-sell spreads, so investors should read disclosure documents carefully.”
Cost continuum: putting pricing in perspective
Given the wide variance of investment styles, asset mix, fund sizes and charging practices, it’s not surprising that management fees range across a considerable spectrum.
The 150 plus funds on the InvestNow platform, for example, cover annual management fees from 0.20% (for example, the Vanguard International Shares Select Exclusions Index Fund) to an estimated 3.26% for the Fisher Funds New Zealand Growth Fund.
Despite the 3% differential between the cheapest and most-expensive funds on InvestNow, just about all of the products carry an annual management fee under 2% while half of those cost 1% or less.
As a rule, lower-cost products tend to follow passive management strategies while actively managed funds are more expensive.
The price difference between active and passive funds makes sense intuitively. Active funds require more resources – people, systems, research etc – than index-style strategies that simply hold and rebalance to an externally determined set of securities.
Many investors are willing to forgo the prospect of potentially higher returns from active management for the relative certainty of receiving market returns less the lower passive fund fees.
“Whilst 25% of the funds we offer are passive, with the balance being actively-managed, our customers broadly fit into one of three equally-sized categories – one third only invest in passive funds, one third only hold actively-managed funds and the final third hold a mixture of both in their managed funds portfolios,” Heath said.
However, other investors are happy to pay more for active management if it delivers returns above an appropriate benchmark over a certain period of time.
Value judgments
The question of whether either active or passive fund investors are getting ‘value for money’, though, remains complex.
A 2020 study commissioned by the FMA of KiwiSaver funds found “no systematic relationship between fees charged and returns received”.
The FMA report says funds labelled as active generally failed to beat their respective market benchmarks after fees over “meaningful periods”.
“Similarly, passive funds typically do not closely replicate their market index after fees,” the paper says.
If the somewhat depressing FMA findings are not much help for the cost-aware investor, a more in-depth 2021 study of the Australian fund industry commissioned by its regulator concludes that while fund managers on average underperform benchmarks after fees “this does not necessarily indicate poor value for money”.
“… there is some evidence that higher fee funds may perform slightly better but not sufficiently to more than outweigh their higher fees,” the Australian Securities and Investments Commission report says. “On the whole, investors are not necessarily better or worse off for selecting higher fee funds.”
Back in NZ, a more recent analysis of the KiwiSaver market by consultancy firm Melville Jessup Weaver (MJW) provides another nuanced and detailed take on the issue.
Importantly, the MJW study found a clear link between the risk profile of funds (conservative, balanced, growth etc) and long-term returns, suggesting investors get what they pay for in broad asset allocation terms.
“As one would expect, there is a positive relationship between risk and return,” the MJW report says. “The best returning funds have been the growth funds lead by Milford and Fisher. At the other end of the spectrum, BNZ’s First Home Buyer Fund has had the lowest return, but it has also been the least volatile.”
MJW also urges investors to look beyond the sticker price when considering fund choices.
“… even the highest fees may be reasonable if these schemes are providing good value for money. Better performance and greater member engagement are two factors that could provide this evidence,” the report says.
Fund investors, like supermarket shoppers, usually arrive at the same conclusion: price is a number; value is a judgment.
To review the funds we offer, their management style, asset classes, fees etc., visit our Range of Funds page.
Fee-thinking: price-check in the fund aisle
Article written by InvestNow – 29th October 2021
Nothing comes for free in this world, but price isn’t everything.
Indeed, while most people are cost-conscious (otherwise supermarkets wouldn’t run ‘special offers’), they are also usually prepared to pay more for perceived quality or ‘value’.
But for managed fund investors the concept of ‘value for money’ – now a major focus for the Financial Markets Authority (FMA) – might be harder to discern than a two-for-one deal on frozen pizzas at Countdown.
In its recently published guidance on ‘Managed fund fees and value for money’, the FMA attempts to nail down the price of investing to a few principles involving scale, service as well as the important – if not widely understood – balance between risk and return.
“Greater transparency about fees and value for money will enable scheme members to make more informed decisions about who they invest with,” the FMA guide says. “It will enable broader scrutiny and commentary from the media, consumer advocates, political stakeholders, and the public, which will help to inform members’ investment decisions.”
Behind the bundle: multiple costs in single sticker
Like many financial products – see mortgages, term deposits and credit cards, for example – managed funds are invariably priced in percentage terms.
The per cent price refers to a proportion of fund assets under management at a given time. Typically, funds accrue the percentage fees in the daily unit price with actual cash payments transferred to the manager on a regular basis – monthly, for instance.
In many cases, but not all, the so-called ‘sticker’ price bundles most of the fund costs into that single number, which covers among other items:
- investment management – ie the various duties involved in investing such as security selection (manager expertise), research, trading, technology and other mundane business expenses;
- administration – systems that accurately implement and track investment orders and member information; often outsourced to external providers;
- supervisor – all regulated funds require a third-party licensed supervisor (previously known as a trustee) to ensure they follow investment and governance guidelines;
- custody – the legal ownership of fund assets; independent custodians (InvestNow uses Adminis for the service) keep member assets at a distance from the manager and make sure investment decisions are implemented efficiently and as per fund rules.
All-in (and off-label)
The majority of managed funds issued in NZ today publish both the single all-in fee as well as a breakdown of some of the underlying cost components in the fund Product Disclosure Statement (PDS).
Furthermore, the fund PDS should also clearly state any other potential fees, or costs, that fall outside the sticker price with examples including ‘individual action’ charges such as fixed dollar entry-and-exit or contribution fees.
Many KiwiSaver schemes also continue to charge member fees (usually expressed in monthly or annual dollar terms): although the practice is dying out, led by InvestNow with the InvestNow KiwiSaver Scheme, which was the first KiwiSaver to launch without fixed dollar member fees.
Outside of KiwiSaver, member fees are highly unusual but at least one provider, Simplicity, does include a fixed dollar annual charge for investing in its retail funds.
Sometimes financial advice fees are also incorporated as part of the management fee, especially in KiwiSaver schemes, while other funds allow adviser charges to be added on to individual accounts.
The difference is critical: embedded advice fees essentially distribute the cost across all fund investors whether they use an adviser or not; while individualised fees attribute the expense to investors who actually seek advice.
Even the regulator is in two minds about how to resolve the fund advice fee issue.
According to the recent FMA guidance, the regulator wants to “avoid a situation where fees for advice are embedded within broader fees paid by all members, are not transparent to members, and result in schemes competing to make offers to advisers to ‘buy’ members from them”.
“We prefer that fees for advice are charged to the member, not the scheme, or are otherwise structured so members can choose not to pay the fee,” the FMA says. “We acknowledge, however, that the KiwiSaver market is still maturing – balances tend to be lower than for other managed funds, and even a moderate, optional fee for advice may dissuade KiwiSaver members from using or seeking it.”
And investors need to watch out for two other common expense categories: performance fees; and, buy-sell spreads (see our article – “Spreads – Why they’re fair”).
Some managers charge performance fees over-and-above the standard fund sticker price if their investment returns beat a pre-set benchmark level over a certain time period.
Again, performance fees are relatively rare in NZ retail funds, but they are used by a few local managers on the InvestNow platform – notably Milford Asset Management and Fisher Funds.
Performance fees can be complex and investors should read disclosure material carefully to understand how each manager justifies and implements them.
Buy-sell spreads, meanwhile, apply to investors as they enter and exit funds (importantly, these are different than fixed dollar ‘individual action’ fees): under the process, investors will pay slightly above the current unit price for buying into a fund and receive a little below the unit price for selling.
The rationale for buy-sell spreads centres on the trading costs imposed on funds as investors choose to move their money in or out (see what AMP Capital, Harbour Asset Management and Russell Investments have said on the topic).
Buy-sell spreads are sometimes portrayed as an unnecessary charge but, according to InvestNow General Manager, Mike Heath, the practice actually ensures all fund investors are treated equitably over time.
“Without buy-sell spreads, investors who remain in the funds end up subsidising the trading costs of those coming in or leaving through receiving lower returns,” Heath said. “Not all NZ funds include buy-sell spreads, so investors should read disclosure documents carefully.”
Cost continuum: putting pricing in perspective
Given the wide variance of investment styles, asset mix, fund sizes and charging practices, it’s not surprising that management fees range across a considerable spectrum.
The 150 plus funds on the InvestNow platform, for example, cover annual management fees from 0.20% (for example, the Vanguard International Shares Select Exclusions Index Fund) to an estimated 3.26% for the Fisher Funds New Zealand Growth Fund.
Despite the 3% differential between the cheapest and most-expensive funds on InvestNow, just about all of the products carry an annual management fee under 2% while half of those cost 1% or less.
As a rule, lower-cost products tend to follow passive management strategies while actively managed funds are more expensive.
The price difference between active and passive funds makes sense intuitively. Active funds require more resources – people, systems, research etc – than index-style strategies that simply hold and rebalance to an externally determined set of securities.
Many investors are willing to forgo the prospect of potentially higher returns from active management for the relative certainty of receiving market returns less the lower passive fund fees.
“Whilst 25% of the funds we offer are passive, with the balance being actively-managed, our customers broadly fit into one of three equally-sized categories – one third only invest in passive funds, one third only hold actively-managed funds and the final third hold a mixture of both in their managed funds portfolios,” Heath said.
However, other investors are happy to pay more for active management if it delivers returns above an appropriate benchmark over a certain period of time.
Value judgments
The question of whether either active or passive fund investors are getting ‘value for money’, though, remains complex.
A 2020 study commissioned by the FMA of KiwiSaver funds found “no systematic relationship between fees charged and returns received”.
The FMA report says funds labelled as active generally failed to beat their respective market benchmarks after fees over “meaningful periods”.
“Similarly, passive funds typically do not closely replicate their market index after fees,” the paper says.
If the somewhat depressing FMA findings are not much help for the cost-aware investor, a more in-depth 2021 study of the Australian fund industry commissioned by its regulator concludes that while fund managers on average underperform benchmarks after fees “this does not necessarily indicate poor value for money”.
“… there is some evidence that higher fee funds may perform slightly better but not sufficiently to more than outweigh their higher fees,” the Australian Securities and Investments Commission report says. “On the whole, investors are not necessarily better or worse off for selecting higher fee funds.”
Back in NZ, a more recent analysis of the KiwiSaver market by consultancy firm Melville Jessup Weaver (MJW) provides another nuanced and detailed take on the issue.
Importantly, the MJW study found a clear link between the risk profile of funds (conservative, balanced, growth etc) and long-term returns, suggesting investors get what they pay for in broad asset allocation terms.
“As one would expect, there is a positive relationship between risk and return,” the MJW report says. “The best returning funds have been the growth funds lead by Milford and Fisher. At the other end of the spectrum, BNZ’s First Home Buyer Fund has had the lowest return, but it has also been the least volatile.”
MJW also urges investors to look beyond the sticker price when considering fund choices.
“… even the highest fees may be reasonable if these schemes are providing good value for money. Better performance and greater member engagement are two factors that could provide this evidence,” the report says.
Fund investors, like supermarket shoppers, usually arrive at the same conclusion: price is a number; value is a judgment.
To review the funds we offer, their management style, asset classes, fees etc., visit our Range of Funds page.
https://www.betashares.com.au/insights/active-passive-or-chimpanzees/
“Unfortunately for active managers, the historic data is not good. The majority of active managers do not consistently outperform their benchmark index once fees are taken into account.”
https://www.guinnessworldrecords.com/world-records/most-successful-chimpanzee-on-wall-street
“Raven, a six-year-old chimpanzee, became the 22nd most successful money manager in the USA after choosing her stocks by throwing darts at a list of 133 internet companies. The chimp created her own index, dubbed MonkeyDex, and in 1999 delivered a 213 per cent gain, outperforming more than 6,000 professional brokers on Wall Street.”
I’ve read that Australian studies have found active managers tend to outperform index funds in the most volatile sectors (such as small cap growth stocks) but struggle to beat index funds when investing in large cap “blue chip” stocks. Also large cap active funds with good tracks records tend to be “high conviction funds” that invest in a relatively small number of stocks that the managers have high confidence in.
Hence, if you want to “beat the market” with active funds then it may be the case that you have to accept more volatility than you would experience by investing in index funds,
If managed investments received a percentage based predominantly on their performance rather than on the overall value of the fund this would be a more equitable means of fee income for them. The investor, too, would be getting better value for their fees paid. Higher performance, higher fee invome, lower performance, lower fee invome.