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While every investor may have their own criteria or checklist to follow when selecting between funds, fund fees should be their first or second consideration, according to a new research carried out by Morningstar’s Russel Kinnel.
“The expense ratio is the most proven predictor of future fund returns – and our data agrees,” Kinnel said in his report published last week, outlining his test to verify fund fees as a strong and dependable predictor of better outcomes.
Kinnel grouped funds into quintiles – five sets based on cost within their peer group – and then rolled that up into an asset class. He looked at five measures to test how expense ratios worked and to calculate a success ratio for all measures. These five measures include total return over the ensuing period, load-adjusted returns, standard deviation, investor returns, and subsequent Morningstar Rating.
The final result showed that the cheapest-quintile funds were three times as likely to succeed as the priciest quintile. Higher-cost funds are much more likely to fail and be merged away.
The number proves that the cost of investing plays an important role in funds selection process- this is also what Morningstar analysts have always emphasized in their research hence in the Morningstar Analyst Rating for Funds.
Price Element in the Morningstar Analyst Rating
Price is one of the five key pillars that Morningstar analysts use to evaluate funds. Analysts will estimate whether the fund is a good value proposition compared with similar funds sold through similar channels. The other four pillars are process performance, people and parent.
The Morningstar Analyst Rating for funds is the summary expression of Morningstar’s forward-looking analysis of a fund. Analysts assign the ratings on a five-tier scale with three positive ratings of Gold, Silver, or Bronze, a Neutral rating and a Negative rating.
If a fund receives a positive rating of Gold, Silver, or Bronze, it means Morningstar analysts think highly of the fund and expect it to outperform over a full market cycle of at least five years. Gold is classified as the best-of-breed fund that distinguishes itself across the five pillars and has garnered the analysts’ highest level of conviction.
As cost of investing is the top element to consider when selecting between funds, using Morningstar Direct and the free-to-use Morningstar Fund Screener, we pick three low cost and highly rated fund for income investors. There are two Silver Rated funds and one Gold Rated fund, as shown below. They might not be the cheapest funds on the market across all sectors but these funds have positive rating in the price pillar by Morningstar analysts – meaning they are among the cheapest when ranked again their sector peers.
3 Low Cost Actively Managed Income Funds
Fidelity MoneyBuilder Income is a Gold Rated fund with an ongoing charge at 0.99%. The charge is slightly lower than the fund’s category median charge of 1.04%, which creates a small tailwind to performance, according to Morningstar analyst Carlos Lucar. He believes that the fund is one of the strongest sterling corporate-bond funds for diversified and core exposure to this asset class.
Lucar has a high opinion of lead manager Ian Spreadbury, given his background and long-term experience as a portfolio manager. Spreadbury has been at the helm since inception, and his presence underpins our conviction. He has gained valuable perspective through his long tenure at Fidelity, his 10 prior years at L&G, and his earlier actuarial career.
The fund manager does a great job in balancing risk and income generation. Their cautious view on economic growth is reflected on their moderately positive view on credit, which is expressed via selection of less cyclical high-conviction names. The outstanding long-term track record is proof of the solid investment approach that emphasises diversification and long-term views, Lucar said. The fund has a 5.6% five years annualised return and it gains 3.9% year to date.
Artemis High Income is a Silver Rated fund with an ongoing charge at 1.32%. It is below the 1.48% median for similar retail share classes within its GBP Cautious Allocation Morningstar Category, Morningstar analyst Ashis Dash said.
The fund is a compelling long-term offering for investors looking for a high-yielding fund, Dash added. Alex Ralph took over as lead manager in July 2015. She manages the fund alongside Adrian Gosden, with Ralph responsible for the fixed-income investments and Gosden for equities.
The fund’s long-term performance has been remarkable with its three, five, and 10-year returns, both absolute and risk-adjusted, ranking within its Morningstar Category’s top decile. Dash believes that the fund demonstrates long-term outperformance potential. The fund has a 6.6% five years annualised return and a 4.9% 10 years annualised return.
Another Silver Rated fund with low cost among its peers is Royal London UK Equity Income. The "A" retail share class' ongoing charge is at 1.29%, around 25 basis points cheaper than that of the Morningstar UK Equity Income retail category median. The Z class – the clean share class available to new investors, is only 0.59% a year. The cost of the fund is favourable relative to its category rivals, Morningstar analyst Samuel Meakin said.
The fund benefits from a highly experienced manager employing a proven strategy consistently. Manager Martin Cholwill has been at the helm of this fund since March 2005. He is a seasoned manager, with more than 30 years’ experience.
Meakin thinks Cholwill’s strategy is sensible for delivering yield and competitive total returns for investors. He targets stocks with strong free cash flow yields that can enhance the prospects of rising dividend payouts; company finances must be strong and those cash flow yields must be sustainable. The fund has a 10.1% five years annualised return and 10 years annualised return at 7.8%.
