Fund Price Versus Performance

Price is an important factor when selecting fund investments, but it's not the be-all and end-all

Emma Wall 15 August, 2014 | 10:00AM
Facebook Twitter LinkedIn

The investment industry has taken a battering over the last couple of years, accused of being too expensive for the masses. Some of this downward price pressure is positive – financial advisers are now regulated to ensure complete cost transparency, while other measures have had a mixed response – such as the restrictive price cap recently introduced on pension funds.

Retail-investor fund charges have also been put under the spotlight. In response, there has been a significant rise in popularity of passive investments, i.e. those investments that follow pre-set investment rules rather than being actively managed by an individual or team of analysts--and therefore typically charge a lower fee, as well as new interest in actively-managed, low-cost passive strategies. 

Yet it's worth remembering that even passive strategies require an element of active decision-making and such asset allocation can hold just as many challenges as stock picking within actively managed funds. Thus, though the lower the price the less it will eat into the investor's returns, price should not be the only factor to consider when choosing an investment.

Morningstar managing director Simon Ewan stressed earlier this year that successful passive investment still requires difficult active decisions. "You still have to time the market well if you want positive returns," he said. "It is therefore an active decision even if implemented passively. A good active manager will always justify their fee."

One might consider that the past five years of strong equity- and bond-market returns would have provided an opportunity for passively-run portfolios to shine – if they had timed their asset allocation correctly. "If price is the only important factor passive strategies should have beaten all actively-managed funds over the past five years," said Hargreaves Lansdown's Mark Dampier. "But that isn't the case."

The Financial Conduct Authority warns investors that a fund's past performance is not an indicator of future returns, but Dan Kemp, head of Portfolio Management at Morningstar, says that it is important that investors separate alpha from beta.

"Price is fixed – a guarantee, whereas performance is not so you can understand why investors fixate on the certainties. But there is a difference between beta – the underlying market performance which is unpredictable, and alpha – which is performance achieved by the active manager. Alpha can be predicted with careful research and that does have an impact on future returns."

Morningstar's analyst ratings identify the fund managers who are most likely to add value in the future by a five pillar process, one of which is price, alongside people, parent, process and performance.

This is not to say price is an unimportant factor, and downward pressure should be placed on the investment industry in order to keep costs competitive, but it is just one factor that should be considered. Passive investments and other low-cost strategies deserve a place in most portfolios, but they should be chosen because an active investment decision has been made about the sector or regional exposure and the provider rather than solely because they are cheap.

As Kemp concludes: "Investors should try to buy a good quality fund, whether active or passively managed, at an attractive price, but the price should not be the initial constraint."

Originally published 14th August 2014. Updated 15th August 2014, removing comments about specific fund performance and assessment factors.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

About Author

Emma Wall  is former Senior International Editor for Morningstar

© Copyright 2024 Morningstar, Inc. All rights reserved.

Terms of Use        Privacy Policy        Modern Slavery Statement        Cookie Settings        Disclosures