Is your fund manager worth their fees?
Simon Turner
Wed 13 Dec 2023 6 minutesAfter the rapid rise in the number of ETFs on offer, investors are faced with more choice than ever when it comes to selecting funds. And with typical managed fund fees running at many multiples of typical ETF fees, investors are increasingly asking the question… is it worth paying the higher fees for an actively managed fund?
The shifting market dynamic
Vanguard, the world’s second largest asset manager, announced a few months ago that it would cut the management fee on its ASX-listed Vanguard Australian Shares ETF from 0.1% p.a. to 0.07% p.a. in response to similar fee cuts by competitors such as Blackrock and Betashares.
It’s good news for Aussie investors. In the context of an average active fund management fee of 1.4% p.a., 0.07% p.a. offers compelling value and sets a new benchmark for Australian ETFs. It was also a significant announcement since this particular ETF has $13.2 billion assets under management (AUM), and is more than twice the size of its next largest competitor.
It’s unlikely to be Vanguard’s last ETF fee cut. They announced that they are committed to ‘gradually reducing management fees’ as their scale increases. Bearing in mind some US ETFs are charging fees as low as 0.02% p.a., there’s ample room for further fee reductions in the coming years.
With fees falling and awareness of the ETF sector rising, it’s hardly surprising the Australian ETF sector has grown from $100k in AUM two decades ago to almost $153 billion. Of course, context is important. The Australian fund management sector had $4.57 trillion assets under management as at June 30th 2023, so the ETF sector has only taken a 3% share of the market thus far. In other words, the active fund management sector still dominates.
However, the outlook for the ETF sector is bullish for the same reasons it’s grown so fast in recent years. According to Betashares investment strategist Tom Wickenden, ‘There is the potential for the industry to grow to a trillion dollars, perhaps even within the next 10 years if this rate of growth continues and the industry achieves the same level of penetration as the US ETF industry.’
Implications for active fund managers
The implications are significant for both investors and active fund managers alike. In particular:
Investors now have a vast and growing universe of low cost ETF funds available to them should they decide to move their assets away from actively managed funds.
Investors are increasingly aware of the attractions of the ETF sector, particularly the low fees and diversification benefits.
Investors are increasingly aware of the relative performance of active versus passive funds, and are less likely to tolerate long term underperformance from their active funds as a result.
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Active fund management shopping list
In the face of these shifting market dynamics, here’s our shopping list for fund managers who are worth their fees…
Managers who’ve developed an information advantage within their asset class. Whilst there are managers in most asset classes who have a demonstrated information advantage, there are some less efficient asset classes where it’s more natural for information advantage to be displayed—e.g. micro, small and mid-caps, credit, and thematic investment funds. This was evidenced in Morningstar’s recent Australian Active/Passive Barometer which showed small and mid-cap managers outperformed passive funds by a substantial margin over 3, 5, and 10 years.
Managers who demonstrate long term outperformance care of a repeatable investment process. Whilst there are many informed and driven fund managers in the market, there are few informed and driven fund managers who outperform over the long term without a clear and repeatable investment process they can articulate and follow.
Managers who don’t benchmark hug. High conviction active fund managers generally reflect their conviction levels in portfolios which don’t resemble their benchmarks. Some would argue the greater the difference between a portfolio and the benchmark the better. However, it should also be pointed out that the dispersion of returns of benchmark agnostic fund managers tends to be wide. For example, Morningstar’s recent Australian Active/Passive Barometer showed the worst small and mid-cap fund returned -12.5% p.a. over five years whereas the best returned 14% p.a.
Managers who hold their positions for the long term. Investors are paying their fund managers to invest in a manner which optimizes their chances of success, which generally means investing for the long term. Pay close attention to average holding periods as a result. It’s also worth comparing portfolio turnover with the manager’s target holding period to ensure consistency.
And what to avoid
Conversely, here’s our list of what to avoid when searching for active fund managers who are worth their fees…
Managers who lack an information advantage. Whilst asset class is a factor, there are high and low quality fund managers in all asset classes. A lack of information advantage tends to be revealed through performance and communication.
Managers who underperform over the long term. It’s important that investors focus on the 3-year, 5-year, and longer performance data for the long term picture.
Managers who lack a clear and repeatable investment process. This should be clearly articulated and is closely associated with long term performance and information advantage.
Managers who benchmark hug. If an active fund manager has a portfolio of 100+ positions which closely resembles the sector breakdown of the index, it’s a sign they are benchmark hugging, or at least overly benchmark aware.
Managers who aggressively trade their portfolios. This is a warning signal on two fronts: a) Short holding periods often indicate a lack of conviction and/or information advantage, and b) Trading costs erode performance.
Active vs passive case study: bond funds
After a volatile year, the bond sector has emerged as one in which active managers have on average been justifying their fees versus the passive fund alternatives.
According to Morningstar’s recent Australian Active/Passive Barometer, actively managed global bond funds outperformed with -3.2% p.a. returns over three years versus -5.1% p.a. for passive funds, and -0.1% p.a. over five years versus -0.3% p.a. for passive funds.
The main reason for this outperformance was that active managers were able to buy shorter dated bonds as a means of offsetting the effects of rising interest rates. This illustrates a key argument in favour of active fund management… active fund managers are able to adjust and customise their strategies as the economic environment shifts.
Some active managers are well worth their fees
The era of investors paying hefty fees to remain invested in underperforming active funds without question is over thanks to the boom in low cost ETFs and growing investor awareness of the alternatives.
Having said that, there are many active fund managers in the Australian market who are well worth their fees as evidenced by long-term benchmark outperformance (after fees) driven by information advantage combined with a disciplined investment process. It’s worth doing your research to ensure you’re investing with that esteemed group.
Disclaimer: This article is prepared by Simon Turner. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.
Simon Turner is an ex-fund manager with 20 years investing experience gained at Bluecrest, Kempen and Singer & Friedlander who now writes educational content about investing and sustainability. He's also the published author of The Connection Game and Secrets of a River Swimmer.
