When choosing investments, one of the first things that might come to mind is how much it is going to cost.
While it should not be the main reason to invest, it can certainly feel like a deciding factor in some cases. It can be offputting, especially when starting an investment journey, to see a chunk of money being taken away before it has had a chance to show any form of performance. For example, if you put £1,000 away into a fund that carries an ongoing charges figure (OCF) of 0.5% then you have already lost £5 on costs alone. Simply put, the OCF is the charge an investor will pay over the course of the year for as long as that investment is held.
There are no set rules or regulations on how much certain funds should cost, but there are some general rules of thumb.
Index trackers or passive funds have traditionally been seen as a low-cost option while investment trusts are typically the other end of the spectrum with higher costs.
As the number of funds available to UK investors increases, so will the demand from investors and subsequently costs may become a bit more competitive.
Using the Morningstar tool to look into average costs, it is clear from the outset that actively managed funds do carry a higher OCF than their passive counterparts.
Looking at funds with an active management style, the majority of funds will have an OCF of between 0.5% and 1.5%, with 36% of 62,319 funds (which include various share classes) having an OCF of 0.5% to 1%. There are only 7.6% of funds with an OCF of 2% or higher.
Passive management shows an entirely different story. With a total 2,174 funds to access, almost 90% have an OCF of less than 0.5%. Passive investments are traditionally known for their lower charges, as shown in the table.
The Costs of ESG Research
You will struggle to read anything about investments at the moment without seeing something about their environmental, social and governance (ESG) features. ESG is a buzzword at the moment, but something that is increasingly important to investors of all backgrounds and savings pots. But many have argued that ESG funds can be more expensive than those without an ESG screen.
TAM Asset Management chief investment officer James Penny says this can be true for some investments, purely because the expertise needed for ESG screens can be much more than other funds. "The cost can be higher because of the due diligence that goes into investing. A non-ethical manager can simply look at a balance sheet to quickly see how well a company is performing. But an ethical or ESG manager needs to drill into the company and pull apart various elements. They need to look at the company's ethos, its DNA and then how the board works. ESG funds can be more expensive because all of the layers of research needed to make them compliant means there is more work involved."
It should be noted, however, that the expense of an ESG fund does not necessarily have to be more expensive than a non-ESG actively managed fund.
The Morningstar Sustainability Rating system measures how well the companies held by a fund are managing their ESG risks and opportunities when compared with similar funds. Using data from ESG ratings and research provider, Sustainalytics, funds are given a score from one to five globes. Using a filter for looking at funds with a score of four or above brings a total 14,494 funds available to this standard. It shows that, compared with active funds, the difference in price is not that great. While there is a slightly higher percentage (of 1 percentage point) of funds with an OCF of higher than 2%, the majority of funds still lie within the 0.5% to 1.5% range.
Are Trusts More Expensive?
Looking at the investment trust world is where the charges change quite significantly. Although it should be noted that closed ended funds have a different structure and way in which they are managed (insofar as having a board to answer to and indeed other costs of having a listed company involve).
Investment trusts have historically been seen as a more expensive route to investing, but the returns tend to be higher on average. While a lot of funds do sit within the 0.5% to 1.5% range, over a third of companies which have an OCF of 2% and above. In fact, nearly 36% of investment trusts have high fees, but it should also be worth remembering that there are far fewer investment trusts available versus the open-ended structure where there are thousands of funds on offer.
It is not just the ongoing charges that investors need to keep in mind, and there is certainly no right or wrong cost to an investment, there are also other charges to keep in mind. When using a platform rather than direct investing, there are administration fees attached to that. Some funds also have performance fees, but these are now few and far between.
Charges should not be the be all and end all of investing, but it is certainly something to keep in mind on a fund that you may not see strong returns on straight away.
