Holly Cook: We all know how fees can eat into your investment returns. So it's important for us to be aware of the costs of the funds that we're buying as investors. To teach us a little bit more about this, I'm joined by Jose Garcia Zarate.
Jose, thanks for joining me.
Jose Garcia Zarate: Thank you for inviting me.
Cook: So, you and the rest of the European Passive-Fund Research team here at Morningstar have just conducted a research report specifically into costs and fees, but looking at exchange-traded products, so that's exchange-traded funds and exchange-traded commodities. And comparing the fee that each of those charge to the dual fee structure of a traditional index tracker fund, for example, because those trackers will charge one fee to an institutional client and one to a retail client. So, what is the main thing that you found out?
Zarate: I think, one of the most interesting findings relates to the fees that are actually being charged to retail investors. And on average, we found that exchange-traded products irrespective of asset class would be cheaper for a retail client than traditional index funds.
Just to give you an example, we found that over 40% of traditional index funds that gives you exposure to European large-cap equity, which is something that most investors would have in their investment portfolios, charge a total expense ratio in excess of 1% for retail clients. We think that probably that's too high and is actually sometimes on par with what actively-managed funds would actually charge you. So, it's difficult to justify from the point of view of the management of what is essentially an index tracker.
Cook: We tend to typically think of tracker funds as being cheap, but as you say if you’re charging more than 1% just to track an index, actually the exchange-traded product could be a better option for the retail investor.
Zarate: It could, it could. And as I said, we have to make the distinction between the retail client and the institutional client, and this is actually something that applies to the retail client.
Cook: And so, we're talking here about total expense ratio [TER], but there are other costs involved in investing.
Zarate: There are other costs involved in investing, irrespective of whether you're using exchange-traded products or traditional index funds. And what we're trying to do in this report is to give investors a comprehensive review and to understand that when assessing costs they have to go beyond the TER. The TER could be the most visible cost but it’s not the only one, and there are other costs that should be taken into consideration and could obviously add up and eat into your returns.
Cook: So you have been looking across the whole of Europe, but are there any other countries that stand out? I think British investors have some good news, right?
Zarate: There are some good news for the UK. We found that for retail investors, the UK is perhaps a much more competitive market place…
Cook: By competitive, you mean cheaper...
Zarate: Cheaper, cheaper, yes, than other European countries, and specifically we compare it to Germany, Italy and France. There could be a variety of reasons. For example, the distribution channel of investment products in the UK is much more open. There is also more of a culture of investment in the UK compared to other countries, like, for example, it is not unusual for an individual to invest for a pension in the future or to have ISAs and all sorts of other investment propositions.
And also, I think it's crucial to understand that there has been a key regulatory change in the UK – the Retail Distribution Review that came into force in January, and already has translated into a lowering of fees for retail clients, for traditional index trackers. So, that's actually good news.
Cook: Well, this sounds like some really crucial and very useful research that you have done here for investors. So, thank you very much for joining us to whet our appetite and teach us a little bit more about costs.
Zarate: Thank you very much.
Cook: The research report we've been talking about is freely available on Morningstar's websites. Thanks for watching.
Read this cost comparison research report "Every Little Helps" by clicking here.
