InvestmentsJun 10 2014

Passive price war beckons?

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Fidelity has slashed fees on its range of tracker funds to record lows, significantly undercutting rivals Vanguard, BlackRock, HSBC and L&G.

For UK retail investors, the Fidelity UK Index fund now costs just 0.07 per cent, its US fund 0.08 per cent, European 0.10 per cent, Emerging Markets 0.23 per cent and World fund 0.18 per cent in OCF terms.

No sooner had Fidelity announced its price reductions, than BlackRock’s iShares cut fees on six of its exchange-traded funds, reducing their total expense ratios by 5 to 28 basis points, although it denies this was in response to Fidelity’s move.

So is this a signal that the price war in the UK passive market is about to intensify?

Dave Penny, managing director at Invest Southwest, says: “I would expect so and I sincerely hope so.

“Clearly, there is much more direct-to-customer interest nowadays, post-RDR, and some very low headline charging makes sense for Fidelity in a competitive market.”

He sees Fidelity’s move as a reaction to the increasing popularity of passive investments, as DIY investors grow in confidence and as financial advisers become more comfortable with the concept, particularly for the more developed investment markets.

Adrian Lowcock, senior investment researcher at Hargreaves Lansdown, sees the move as part of a welcome trend towards lower fees in passive funds.

“It is good to see competition in the market driving down the cost of investing, both active and passive.”

Alan Smith, chief executive at Capital Asset Management, describes Fidelity’s move as “very bullish”, adding that it will be interesting to see how Vanguard, in particular, will respond.

“They have the global scale to undercut anyone should they choose to,” he claims.

When asked to comment on its competitors’ moves, Nick Blake, Vanguard’s head of retail, explained: “As our assets under management increase globally, we can continue to reduce expense ratios for the investors in our funds.”

So will advisers and fund-of-fund managers buy passives from Fidelity, given its tracker range will also carry higher fees when bought through other fund supermarkets – an added 0.02 per cent above Fidelity’s own supermarket price?

Mr Penny says: “For the right client, we certainly would recommend such funds as part of a spread portfolio. The argument for passive versus actively managed funds is being more effectively made now and, in the developed markets, there is plenty of active funds that underperform the sector average.”

Mr Lowcock says: “Cost is an important part of total returns, particularly when it comes to passive investments. However, it is not the only consideration. Tracking error and suitability of the benchmark should also be considered.

“In addition, advisers and fund-of-fund managers need to consider whether passive is the right approach. In some sectors, passives work well, whilst in others active management offers attractive solutions.”

Mr Smith thinks many advisers will be looking very closely at the Fidelity range, as the pricing structure undercuts the rest of the market by a significant margin.

“Advisers who have been using active funds, which are still charging more than 200bps inclusive of all hidden costs, would be foolish to ignore the funds,” he said.

So are we witnessing in the UK the beginning of pricing similar to that in the US, where companies have been undercutting each other fiercely?

Mr Lowcock believes the huge size of the US passive market enables investors to benefit from economies of scale and that while the cost of investing continues to fall in the UK, it is unlikely that funds in this country will reach the size of their US peers and therefore will not benefit from the same cost savings.

Mr Smith believes there is still room for further downward pressure on passive fees, but agrees that the UK will never match the scale of the US market and the appetite of US retail investors to buy mutual funds.

“But if we can get close to the pricing they offer over there, it will be a good thing for UK investors.”

So is it a given that other groups offering passive funds in the UK, such as L&G, Vanguard and HSBC, will respond?

Mr Penny says Fidelity and FundsNetwork are a force to be reckoned with and it would be unwise for any of their competitors to be so complacent as to ignore their moves.

“At such an important time in the development of the advisory and the direct customer markets, any significant ‘land grab’ in market share could stick for the long term,” he says.

Mr Lowcock says: “It is a fiercely competitive market and size of the fund does matter. The larger they are, the more they benefit from economies of scale. We have seen fund groups respond in the past, so I am sure we’ll see it again.”

Mr Smith says there is definitely a price war going on and that the new world of increased transparency will compel other groups to respond.

But he warns that advisers will also be under pressure from clients over their fees and will need to ensure they have a very compelling proposition in order to defend and maintain their fee model.

As providers jostle to become the cheapest provider in the UK, it may be only a matter of time before another round of price cutting breaks out.