The Retail Distribution Review (RDR) has cast fresh light on charges within the investment fund world. For many years investment trusts were considered cheaper in terms of annual management fees than their open ended counterparts, largely due to the lack of retrocession payments. But as the tide has retreated, driven by the RDR, it has become increasingly clear who has been bathing exposed.
At Morningstar we are passionate about championing investor interests, and costs form an important element of our overall assessment of a strategy. Various studies have shown that it is one of the most important aspects of fund analysis, and unlike qualitative judgements such as the merits, or otherwise, of the fund manager’s abilities, the effectiveness and repeatability of the process and a judgment as to the custodianship of the fund house, it is fairly easily analysed.
Whilst this piece focuses primarily on the closed-end world, at Morningstar we are agnostic as to how investments are structured, whether via OEIC, SICAV, investment trust or ETF. Thus, when we are assessing the cost of an investment trust in terms of its ongoing charge*, including performance fees if appropriate, we compare it within its broader Morningstar Category and against the whole range of other investments available within it. Whilst the RDR, clean share classes and platforms have changed the nature of how retail investors access, pay for and hold their investments, the ongoing momentum behind passives is a game changer for all active managers, whether investment trusts or not.
The response to super clean or institutional share classes as well as passives has been gradual but undeniable, as boards have recognised the threat and opportunities afforded by the RDR. Over the past 12 months to August 2017 there have been over 30 instances where boards of conventional investment trusts have amended the fees payable by shareholders. There is no clear trend as to which Morningstar categories are most affected, but there are instances where poor performance or persistent and wide discounts have led to reduced fees being negotiated by boards. Around half of these changes have involved reduced annual management charges and restructured performance fee arrangements, with the other half introducing tiered annual management charges. Overwhelmingly the direction of travel in fees is downward within the investment trust sector over the past 12 months.
We applaud the removal or restructuring of performance fees which can be difficult for investors to understand, and in many cases are poorly structured with commensurately high initial annual management fees and short term investment horizons. We feel strongly that as their assets increase, investors should benefit and share from economies of scale as the effects of fixed fees are reduced. Tiered management fees are a neat solution to this issue, but have historically been instigated relatively infrequently by boards as a matter of course, which we think is disappointing. Boards have a fiduciary requirement to act in the interests of shareholders and enacting more competitive fee structures for the benefit of shareholders would seem an ideal way of illustrating this. Too often boards seem unaware of the broader universe of offerings and choice available to investors within their given sector, such as ETFs, and the competitiveness or otherwise of their pricing structure within it.
Of course, value is not measured alone by a single ongoing charge figure, but when reliable market exposure can be bought for a few percentage points it is a pertinent issue with the numbers of truly successful long term active managers relatively few in number. But investors might be happier to pay higher ongoing charges to access top drawer funds, for example the Alexander Darwall managed and Gold Rated Jupiter European Opportunities Trust (JEO). The fund charges one of the higher ongoing charges in the sector of 1.88%, including performance fee, but has seen handsome outperformance over the past 10 years. Nevertheless, investors must recognise that fees will always take the edge off total returns, so they should always be mindful of fund charges.
*Latest Total Expense Ratio - post tax, excluding interest, transaction and restructuring costs divided by average Net Assets
