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Do expensive funds provide value for money?

By , 28 Jun 17

When investors decide to buy a fund that charges higher-than-average fees, they presumably do so because they expect the manager to compensate for this by delivering outperformance.

When investors decide to buy a fund that charges higher-than-average fees, they presumably do so because they expect the manager to compensate for this by delivering outperformance.

In its asset management Market Study, published on Wednesday, the Financial Conduct Authority (FCA, the UK financial regulator) looked into the matter. In two of the three asset classes it examined, it found no evidence that expensive funds generate higher returns, even before costs.

Moreover, the regulator found “some evidence that the impact of higher fees for more expensive active funds on average has meant that they underperformed cheaper active funds.” And it added: “Overall, there does not appear to be a clear linear relationship between fund charges and the gross performance generated by the fund manager.”

The UK regulator assessed performance for UK, European and global equity funds available for sale in the country using two performance measures: returns against the benchmark and the Sharpe ratio.

The FCA’s research found a statistically significant link between fees and net (under)performance for both UK and global equity funds, with the latter asset class showing the strongest relationship (see graph above).

“For the period examined [2006-2015], more expensive funds have produced worse returns for the investor”

Expensive global equity funds generate similar, or even slightly worse returns than cheaper funds, and Sharpe ratios are identical. The logical consequence of this is that, failing to outperform their cheaper peers, the net performance of expensive global equity funds looks pretty dismal.

“For the period examined [2006-2015], more expensive funds have produced worse returns for the investor”, the FCA concluded.

Value for money – in Europe

But there’s one asset class where expensive managers provide value for money, and that’s European equities. Thanks to the excellent performance of a couple of relatively expensive funds, “the line of best fit indicates that relatively more expensive active [European equity] funds have on average provided better gross performance than those charging lower prices,” the FCA said in its report.

The gross outperformance of expensive European equities is not statistically significant for large cap funds only, but it is when mid- and small cap funds are added to the sample. However, it is wiped out completely when fees are taken into account. But at least, expensive European equity funds are not a rip-off.

Tags: Asset Management | FCA | Investment Strategy

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