Holly Cook: Fund fees play an important role in determining the performance of your portfolio, and I'm joined today by Chris Traulsen, Director of Fund Research Europe, to talk about some research that he's recently conducted in the fixed income space.
Chris, thanks very much for joining me.
Chris Traulsen: Thanks for having me, Holly.
Cook: So, why don't you tell us at a broad level, why is it that fund fees are so important for investors?
Traulsen: Well, if you think about the world of investing, there is so much that's variable: managers can come and go; styles can go in and out of favour; asset classes can go in and out of favour; but fund fees are a constant. They are a fixed negative amount when they compound through time. So, we like to think of it as pure negative alpha that compounds through time and it really dramatically affects investors' long-term returns.
Cook: We're looking specifically at fixed income today, why is it then that this is so important for a bond fund investor given the current investing environment?
Traulsen: Well, if you think about where we are now, interest rates are at historic lows, yields are quite low, and even in the best of times returns on bond funds are disproportionately affected by fees because returns are generally lower and less volatile, and more compressed in terms of range than with other types of funds. So, fees are always important there. They are especially important now.
Cook: So Morningstar has conducted a huge amount of research into this and you've specifically done some research recently looking at the UK fund space and looking at the fixed income space, what has your research shown?
Traulsen: Yes. So you're right. We've done a lot of research through time and not just us, by the way, independent academics have done the same thing to show that fees are one of the most predictive things you can look at in terms of determining future outperformance of funds. Within the UK, we looked at UK bond funds and we split them into performance quintiles. And so we look at the top quintile, the next quintile and the worst performing quintile, et cetera.
And what we found is fees tracked in a very linear fashion. So, the average TER [total expense ratio] of the top performing quintile is far lower than that of the bottom performing quintile. The second best performing quintile has lower fees than the third best performing quintile, et cetera. And it was really dramatic sort of linear relationship. It very clearly shows that investors do need to be paying attention to fees in that space.
Cook: So, lower fees do equal better performance at an overall level?
Traulsen: Yeah, I mean that's a little bit of a simplification, but yes all else being equal, lower fees give you much better odds of outperforming than paying higher fees, yes.
Cook: So what would be considered sort of an average low fee for a bond fund investor in the actively managed space?
Traulsen: Yeah. Well, it really does vary by the type of bond fund you are talking about. So, government bonds will be the lowest sort of fee area, because that's where it's hardest to add value, because you can go out and buy gilts and there is not a lot of ‘stock picking’ to be done there, as it were. For that the median fee is 55 basis points. So I would think if you're paying much over that, you're making mistake certainly. For more diversified funds you're looking at anywhere from 80 to 90 basis points, and I would say if you're paying up much more than that you're making a mistake and really stacking the odds against you.
Cook: How about in the passive space because they tend to have lower fees?
Traulsen: Yeah, in the passive space again it varies tremendously by the vehicle you're using, and whether it's an open-end fund or an ETF, but you should be able to get one from anywhere from 10 to 30 basis points.
Cook: Is there any situation whereby it might be worthwhile considering paying more for a fund or really should fees be your very first starting point?
Traulsen: It's so hard to control all the different variables and certainly we have a qualitative research team that will point to funds where they do think it's worth paying up for and if you have access to that kind of research and you have the patience to sort through it, that can be one way to go. But certainly as a first cut for your average investor, fees are a very good first cut, but you can't ignore other things at the expense of fees. You also need to understand is it a competent manager, is he delivering the kind of results that you would expect, how does this fit within my portfolio, et cetera.
Cook: I think this is really important information for our investors to help them in their decision making process. So thanks very much for joining me Chris.
Traulsen: Great. Thank you, Holly.
Cook: For Morningstar, I am Holly Cook. Thanks for watching.
