Fund fees are falling, according to the latest Global Investor Experience study, but there is still room for improvement in the UK.
Morningstar launched the Global Investor Experience study (GIE) in 2009. It is produced every two years, with 2019 marking the sixth edition and looks at four key areas: Fees and Expenses; Regulation and Taxation; Disclosure; Sales
This chapter of the report focuses on Fees and Expenses.
The GIE study reflects Morningstar's views about what makes a good experience for fund investors. As a general rule, we favour effective regulation of funds that promotes transparency and polices misleading statements and conflicts of interest; low tax burdens on investors; comprehensive, easy-to-understand disclosure; a varied distribution system that gives investors multiple ways in which to purchase funds; media coverage that helps to educate investors; and, most importantly for this chapter of our GIE study, competitive fund fees.
Fees are Falling
We are continuing to see a trend towards lower fund fees globally and the majority of the 26 markets we studied saw the asset-weighted median expense ratios for locally domiciled and available-for-sale funds fall since the 2017 study.
There are several factors driving fees lower:
- Regulation - including the UK Retail Distribution Review
- Awareness - retail investors are increasingly aware of the importance of minimising investment costs, which has led them to favour lower-cost fund share classes.
- Unbundling – the move towards fee-based financial advice has spurred the demand for lower-cost funds like passives.
- Competition - in the larger and more competitive markets, asset managers have been cutting fees to vie for market share.
Taken together, bans on sales loads, continued decoupling of fund expenses from advice charges, bans on commissions, and mandatory fee transparency have seen many investors pay less for funds than ever before.
Best and Worst Markets
Australia, the Netherlands, and the US receive the best grades in this year's study of fees and expenses. This is the third study in a row that these three countries have nabbed the highest grade in this area.
What these markets have in common is ongoing fund fees that are typically unbundled. Asset-weighted fees in the large US and Australian marketplaces show the effect of economies of scale and competition.
Also notable, the US and Australian markets are closed to funds domiciled elsewhere, so their low expenses for locally domiciled funds are not affected by more-expensive offshore funds when calculating the available-for-sale expenses.
Meanwhile, Italy and Taiwan receive the lowest grades in this year's study. This is the second consecutive study in which Taiwan has received a grade of Bottom for fees and expenses.
Taiwan's asset-weighted median fees for fixed-income funds are the highest among markets in this study, partly driven by its heavy concentration in funds that invest in higher-cost markets, such as emerging markets debt and high yield. These high expenses, a fund industry structure that perpetuates the use of initial charges and retrocessions, and excessive new fund launches that include many expensive funds drive Taiwan's Bottom grade.
Italy falls to a Bottom grade owing to individual investors' routinely being subjected to initial charges and retrocessions, as well as the country's funds having some of the highest asset-weighted median expense ratios we measure
Fees in the UK
The United Kingdom’s Fees and Expenses grade is Above Average. Investor-friendly regulation, such as the banning of front loads as a means of paying commission to distributors and the separation of advice fees from embedded ongoing charges, contributes positively to the country’s overall score.
However, owing in part to the grandfathering of existing assets in traditional fee structures, the UK’s asset-weighted median expenses are on the whole less competitive than those of Top-rated markets. UK-domiciled funds carry median expenses of 1.03% for allocation, 0.95% for equity, and 0.77% for fixed income. Expense ratios of funds domiciled in the UK are lower on average than those domiciled outside the UK.
In the UK, under the rules generated by the Retail Distribution Review (RDR), which came into effect in January 2013, most new investments now flow into share classes that are free of sales charges and ongoing trail commissions. An exception is made for restricted advisers who elect to offer only “basic advice”, although here strict disclosures are mandated.
The RDR also mandated that investors pay for advice as a separate fee, instead of through embedded trail commissions. This resulted in the mass creation of share classes that investors are able to purchase without paying a load or retrocessions. Some share classes still report the ability to charge a front load, but these are usually a legacy issue rather than an actual deduction of money from an investment.
Prior to the implementation of RDR, between 50% and 75% of both share classes available for sale and domiciled in the UK reported a front load, and both the load and breakpoints were negotiable with the sales agent. Legacy assets invested in retrocession-led share classes still exist, but the Financial Conduct Authority (FCA) is looking at ways to ensure these assets get switched into unbundled share classes.
Funds are permitted to charge performance fees that are asymmetric insofar as they increase the cost to the investors in the case of outperformance but do not decrease the cost to the investor in the case of underperformance. However, there are instances of fund groups in the UK trying something different. For example, one fund group has very recently brought fulcrum fees to the market. Here investors pay less when a fund underperforms. However, the terms of performance fees are frequently too complex for a typical investor to be able to accurately estimate total expenses, including performance fees.
Exchange-traded fund usage among retail investors is low in the UK and historically, retail investors have tended to use index-tracking funds for passive exposure rather than ETFs, given the former have been available for many years. This is gradually changing through the emergence of robo-advisers that make significant use of ETFs. There is a wide choice on investment platforms encompassing ETFs domiciled in different European jurisdictions. ETFs listed in the London Stock Exchange are not subject to UK stamp duty, but given their stock-like characteristics, trading ETFs will incur expenses such as brokerage commissions and bid/offer spreads.
How the Study Analyses Fees
Given the differences in the way fees are calculated, reported, and named across different markets, it can be difficult to ensure like-for-like comparisons. Since the conclusion of our 2017 GIE study, we have introduced a new data point, 'Representative Cost,' that standardises annual fund expenses globally, facilitating comparison across markets.
Representative Cost captures recurring costs charged by the fund vehicle, including embedded distribution fees, retrocessions, and performance fees. It excludes one-off fees charged by third parties such as advisers or platforms, as well as front-end or deferred sales loads and redemption charges.
In many markets, Representative Cost uses the Annual Report Net Expense ratio. In European countries it incorporates the forward-looking MiFID Ongoing Cost–Estimated (with any accompanying performance fee), though it will use a series of potential substitutes, like KIID Ongoing Charge, if that data point is not available.
While acknowledging that within a bundled fee environment the investor experience can be adequate, Morningstar maintains that by lowering the cost of investment products via commission-free share classes and by unbundling other expenses from the cost of investment management, transparency improves and investors benefit. In addition to lowering all-in costs for do-it-yourself investors, those participating in a fee-based advice model may accrue additional benefits from more-individualised service, including savings guidance, tax planning, and pension optimisation, which collectively add significant value to the investor experience.
Additionally, when paying directly for advice, an investor can avoid the inherent conflict of interest that occurs when advisers are compensated for promoting specific products. In the worst possible outcomes from 'bundling,' investors run not only the risk of receiving poor quality advice, but of receiving no advice at all. In Australia, for example, the recent Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry laid bare repeated instances of Australia's financial service providers charging 'ongoing service fees' where no service was ever delivered.
