InvestmentsJun 20 2016

Passives highlight new focus on value

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
Passives highlight new focus on value

Passive providers have been slashing fees across their product ranges for the past couple of years, in what at one stage was dubbed a ‘price war’ as fund groups appeared to race to the bottom.

Investors have continued piling into passive funds, whether they are index trackers or exchange-traded funds (ETFs), frequently citing the lower charges as an attraction.

Recent research by FE Trustnet among 2,637 investors and advisers, reveals 22 per cent would not pay more than 0.75 per cent in ongoing charges figure (OCF) for an active UK equity fund.

This means they would miss out on around 90 per cent of the funds available in the market, the research suggests. It also found 37 per cent of those polled would not pay more than 1 per cent in charges for an active UK equity fund, while the average active fund OCF is 0.9975 per cent, according to FE Analytics data.

What this highlights is the increasing pressure on active asset managers to match the perceived value of passive products.

Mika-John Southworth, director at FE Trustnet, points out what is not clear from the research is at what stage advisers and investors are applying this cost filter in their decision-making process.

“The risk is that cost filter becomes an almost automatic active/passive filter,” he says. “The passive fund issue has introduced a new focus on value in the market. I think that is a really good focus to have.”

He suggests the onus is on the fund industry to justify costs and charges.

Simon Hynes, head of UK retail sales at Legal & General Investment Management, observes one of the biggest funds over the past few years in terms of assets under management is Standard Life Investments’ Gars strategy, which he says is retailing at approximately 89 basis points on some platforms.

“With proven active funds, people are prepared to pay,” he asserts. “For some people, value means performance, for others it’s just simply the lower cost.”

Increased scrutiny: Expert views

Howie Li, executive director, and co-head of ETF Securities’ Canvas platform, comments on how the active management industry responded to lower cost passive funds:

“There remains a central place for active investment strategies in many portfolios but increased transparency and democratisation of the asset management industry has led to a debate about how often genuine outperformance, net of fees, is deliverable consistently.

“This has led to much more scrutiny as to how similar the behaviour of an active strategy is to an equivalent passive benchmark.

“What is clear is that active managers will always have a role where (i) their strategy is differentiated from a lower cost index and (ii) can deliver additional returns or manage risk more effectively.

“This scrutiny is benefiting the end investor as the pressure on the investment value chain continues to build. This has led to stronger efforts in due diligence to ensure that the chosen investment can deliver sufficient additional value to justify any increase in cost over a passive solution.

“That said, even these active strategies are being challenged by new and differentiated products that provide exposure to specialist markets, views or investment approaches.”

There is another reason for the growing emphasis on cost among investors, Source’s Chris Mellor, executive director in equities product management, explains. “If you look at what’s driving costs down, we are seeing lower fees in broad, basic vanilla ETF-type products, we’re also seeing pressure on active managers to reduce their fees and quite right.

“What’s driving that is the lower-return world in which we live. Expected returns are relatively lower and, therefore, costs become a much bigger part of your potential performance or the potential impact on your performance.”

Mr Mellor continues: “In a world where you’re getting 10 per cent in returns per annum, a 1 per cent or 1.5 per cent fee for an active fund is not too big. In a world where you’re getting 2 or 3 per cent per year if you’re lucky, then 1.5 per cent is eroding an awful lot of your returns – and that’s if you’re getting those sort of returns in the first place.”

But he insists cost is only one part of comparing active and passive funds. “Perhaps the most important question you should be asking when deciding on an investment is, ‘does this ETF deliver what I want in my portfolio, does it give me the exposure I’m looking for?’”

Will more platforms start to offer ETFs?

Simon Hynes, head of UK retail sales at Legal & General Investment Management, suggests:

“I think ETFs will become more popular but, at the moment, IFAs have an access issue with some of the leading fund platforms not able to host ETFs just now. However, I think that will improve over the coming years.

“The full wrap platforms have the ability to trade shares as well as funds, and ETFs and investment trusts can all be traded quite capably. But the old fund supermarket models that have become wraps or are in the process of becoming wraps have found it more difficult to host ETFs.

“[There are] requests for it from ETF providers and increasingly from advisers; also robo-advice solutions tend to use ETFs. There’s pressure for ETFs to be more widely available.”

As Amanda Rebello, Deutsche Asset Management’s head of ETF distribution, points out: “It doesn’t have to be a binary choice between passive and active. Some investors will focus on identifying when it makes sense to buy a lower-cost passive vehicle and when it makes sense to pay an active manager potentially higher fees to deliver a return above the benchmark.

“In reality, this perhaps does not put pressure on active managers to reduce fees, but rather to ensure they deliver outperformance versus the benchmark.”

So is there further for fees to fall among passive funds? Mr Hynes believes so: “With passive funds the broad index funds are already very competitively priced. But in the more esoteric areas where there’s not as much competition, there probably is room for fees to fall further over time.”

Fees and charges: Key figures

0.9975%

Average active fund ongoing charges figure (OCF)

22%

Percentage of investors and advisers who would not pay more than 0.75 per cent OCF for an active UK equity fund (Source: FE Trustnet)

89%

Percentage of 150 advisers and wealth managers polled by Source who cited costs as one of the top reasons for using ETFs to meet their investment needs over other investment vehicles

He observes the “Vanguard effect” in the US market as “one to watch” in the UK should ETFs become more widely used here. “If there’s a sector in the US where Vanguard doesn’t have an ETF offering, fees tend to be higher and, as soon as they enter that sector, it tends to drive down fees,” he explains.

The issue of cost remains a central tenet of the active versus passive debate.

Mr Mellor concludes: “Maybe if we see a return to more normal conditions and better returns then fee pressure will be reduced but, at the moment, the focus is firmly there. And it’s firmly on getting the best performance you can for every dollar or pound that you’re spending.”

Ellie Duncan is deputy features editor at Investment Adviser