Fund managers’ best kept secret: cost IS a guide to future investment performance

There are miles of billboards and acres of newspaper pages filled by the fund management industry with sales and marketing hype about performance, but very little about the impact of costs.  David Norman of TCF Investment said, “Advisers and planners should ensure that expense ratios are one of the top factors used when selecting funds.  Our analysis shows that TERs are a very strong predictor of investment returns. This is a clear example of when common sense makes good investment sense.”

TCF Investment looked at the returns of the three IMA Managed sectors. It ranked all the funds in the sector by current Total Expense Ratio (TER). It then looked at the performance of the low cost quartile (cheapest 25%) and the highest cost quartile (most expensive 25%) relative to the average performance of all funds over 3 and 5 years:

Sector	Quartile Cost	Performance 3 years %pa	Performance 5 years %pa
ACTIVE	Cheapest	6.36	4.59
	Dearest	5.20	3.52
	Dearest  less cheapest	1.15	1.08
	Sector average	6.16	4.14
BALANCED	Cheapest	6.26	3.94
	Dearest	5.16	3.04
	Dearest  less cheapest	1.10	0.90
	Sector average	5.81	3.68
CAUTIOUS	Cheapest	5.05	2.90
	Dearest	5.05	2.31
	Dearest  less cheapest	0	0.59
	Sector average	5.19	2.74

Source: Morningstar 2011

The analysis shows that the lower costs are a very strong predictor of future returns – beating or meeting the returns from their higher cost peers in every case.  

Yet despite the clear evidence of the pivotal significance of cost when choosing a fund, there is effectively no price competition across the UK fund management industry.  Investors and their advisers need to take a proper, careful look at Total Expense Ratios (TERs) and Portfolio Turnover Rates (PTRs) of funds when choosing one fund over another.

Norman  said, “The truth is that cost is an extremely strong predictor of future relative performance and yet the industry does its best to hide this from the investor and his or her adviser. Prices for active funds vary very little indeed (source: Lipper), are steadily increasing (source Lipper), fail to decrease with the size of the fund (source: IMA and Morningstar) and look far too much like an oligopoly to be healthy.”

“Investors and advisers need to remember that every pound of investment cost is a pound lost – forever.  In the current low return environment high costs means investors are effectively trying to walk up the down escalator – a sure fire way to get nowhere fast”.

TCF Investment is committed to clarity and fairness in all its dealings and is actively campaigning for radical improvement in the behaviour of that part of the investment industry that would seem to have forgotten whose money it is they are investing.

The TCF Investment website provides a continually expanding range of useful materials and content to help advisers and their clients know where the worst traps laid by the sector lurk and how to avoid them through seeking an enlightened, fair and transparent alternative. This content includes further details on the issues raised in this press release.