Is it worth paying big fees for some funds? High performers can outweigh the extra cost, but picking winners is a tough game
When it comes to investing, high charges don’t necessarily mean bad value. But at the same time, no one wants to be ripped off by a fund manager who delivers rotten performance with charges that eat into your savings.
Reports this week suggested that the City watchdog, which is conducting a review of fund managers, will not be imposing a charge cap on investment funds.
As part of this review, which has so far cost more than £1m, the Financial Conduct Authority was thought to be considering introducing a maximum annual charge which funds could levy on savers.
Its decision not to means it has never been more important for savers to do groundwork and know what they’re paying before they put their money into a fund.
Charges, which are expressed as a percentage of the amount you invest, erode your returns over time.
Let’s imagine you have a choice of two funds. You invest £15,000 for ten years and each of those funds returns 5 per cent a year over that period.
The first has an annual charge of 0.8 per cent. If you chose that one then after ten years you would have paid charges totalling £1,772, while your money would have grown to £22,662.
The second charges 1.5 per cent a year, meaning you would have paid £3,427 in fees over the same period leaving you with a significantly smaller saving pot of £21,006.
Tom Stevenson, investment director at Fidelity, says: ‘While the difference between fund fees might be only a fraction of a percent, you have to be aware of the effect of compounding over time.’
Overpaying just a small amount for the same performance leaves you massively out of pocket.
And worse than paying too much and only getting average performance is overpaying for a fund which is underperforming.
According to data from Bestinvest, over the past five years the funds which have performed the worst have charged the most.
But choosing a fund based solely on how much it costs is clearly not the way to go about things. Any investor using that strategy is just going to end up with a basket of FTSE tracker funds, which might be cheap but will never outperform the stock market.
Jason Hollands, managing director at Bestinvest, says: ‘What savers need to focus on is value for money, which is ultimately the return you get after fees, not just fees alone.
‘For a really great fund manager who can significantly outperform his rivals, it may be worth paying above-average fees. But the higher the charge the more conviction you have to have in the manager’s skills. I’m personally very happy to pay a fee for someone who is going to make me more money than I would get in a lower-cost alternative.’
At first glance, for example, the Evenlode Income fund might seem a bit pricey at 0.95 per cent a year. But the fund is the top performer of the 266 funds in the UK All Companies sector over the past year. Over five years it has turned £1,000 into £2,136, compared to an average return of £1,654 among rivals, according to figures from Trustnet.
The Ardevora UK Income fund comes in at a hefty cost of 1.35 per cent a year. But over five years the fund has returned 103 per cent compared with an average among its rivals in the UK Equity Income sector of 70.7 per cent.
While these funds have their own approaches, the common theme with those that outperform tends to be they are actively managed – the manager is finding hidden opportunities.
Kelly Prior, investment manager in the F&C Multi-Manager fund team, says: ‘Finding managers who can do this is akin to searching for a football player who can be everything from goalkeeper to star striker. But it is possible to find specialists who deserve to be paid for their skill.’
OR WOULD YOU BE BETTER OFF WITH A LOW COST TRACKER?
The counter-argument to paying fund managers' high fees has been put forward in countless studies that show how difficult it is to consistently beat the marekt long-term.
The alternative put forward is passive investment, using tracker funds and ETFs to follow an index and rely on the ability of companies to grow their profits and pay dividends over time for your returns.
These will never beat the market, but they will also not fall behind and their lower costs can compound up to make a big difference over the long-term.
Fans of tracker investing say that by following an index you remove the mistakes that can be made by trying to pick winners - either your fund manager's or your own - which can seriously dent your wealth.
Traditional tracker funds and exchange traded funds are grouped together under the index investing bracket but operate in different ways.
ETFs are traded in the same way as individual shares, such as on the London Stock Exchange, while trackers are set up like an investment fund with the fund management house selling units.
You can buy direct from the ETF provider or fund management house, but in both cases investors usually buy and sell via a DIY investing platform.