A number of notable investment trust names have reduced their charges of late, but open-ended funds fail to pass on economies of scale.
City of London, the investment trust that boasts the longest dividend growth streak of 52 consecutive years, has become the latest investment trust to cut its fees.
The management fee cut, revealed in City of London’s half-yearly report released last week, took effect from the start of 2019 and equates to a reduction of about 10%. This should filter through into the ongoing charges figure, currently 0.41%. The fee reduction is all the more notable given that City of London is already one of the cheapest options for UK equity exposure.
City of London’s board said it had negotiated the reduction with the management group, Janus Henderson. Other boards have also become more proactive of late, including Lowland, Templeton Emerging Markets and Schroder Asia Pacific, who all cut fees last year.
In addition, over the past couple of years, Baillie Gifford has reduced management fees on other trusts it manages, including Scottish Mortgage and Monks.
The fee cuts are welcome news for investors as charges nibble away at returns; this is made worse over the long term by the phenomenon of compounding.
Arguably, for self-directed investors, charges are something that can be controlled by avoiding funds that do not back up their premium prices with premium performance. As a rule of thumb, investors should look twice at any actively managed fund or investment trust that has an ongoing charges figure of over 1%.
Some offer considerable value and their relatively high charges versus peers can be explained. For example, boutique fund managers will have higher overheads than a behemoth asset manager with tens of billions of pounds under management, that is able to take advantage of economies of scale. Moreover, boutique managers that focus on niche assets are likely to command a higher price tag, as more research and legal work is required.
In the case of open-ended funds charges have also been falling – but not in the same way, as we explain below. According to research by Morningstar, active equity funds have cut fees by an average of 18% since 2013 on an asset-weighted basis.
The Retail Distribution Review (RDR) has been the driver behind this. By requiring investment funds to provide greater disclosure on fund fees, the full extent of charges paid by investors has become clearer. The increased transparency stoked some competition between fund providers and greater price discrimination by investors.
Not all fund firms opted to cut their fees, however; many decided to keep charges the same, while a small number took the opportunity to increase their charges.
Interestingly, the same Morningstar study found that passive funds over the same time period had made bigger reductions, of 28% on average.
The reason why active funds generally do not cut their fees as frequently as investment trusts is largely down to the fact that in the vast majority of cases open-ended funds, whether they are structured as oeics or unit trusts, do not pass on economies of scale. The same fee is levied even if the fund grows from £100 million to £10 billion.
In contrast, in the case of investment trusts increasing numbers have been moving to offer a tiered fee structure, under which the charges paid by investors decline progressively as the trust becomes bigger.
There are a couple of reasons why this is the case, but the main one is the fact that investment trusts, unlike open-ended funds, are overseen by independent boards. It is their duty to act in the best interests of investors, and driving down costs is part of their remit.
Open-ended funds do not have boards, although later this year that is set to change following intervention from the Financial Conduct Authority. From September, all asset managers will be required to have at least two independent directors on their boards, and these independents will have to comprise at least 25% of the board.
Moreover, in its final report into the asset management industry last year, which took two and a half years, the FCA made the point that retail investors fail to benefit from economies of scale. It pointed out that active management fees have “remained broadly stable over the past ten years”.
Investor inertia is the other key reason why a price war has not played out among open-ended funds. There are billions of pounds invested in sub-standard active funds, and until investors vote with their feet, charges will remain the same. If a fund has £300 million of ‘sticky assets’, there’s no incentive from a chief executive’s point of view to cut charges and receive less in fund fees.