Investors need to watch for the link between high fund fees and low performance – especially if they are on a fixed income.
New research shows the yield depends on the total expense ratio (TER) of the fund
The TER measures the costs associated with managing and operating an investment.
These costs mainly include management fees and additional expenses such as trading fees, legal fees, auditor fees and other operational expenses.
The total cost of the fund is divided by the fund’s total assets to arrive at a percentage amount, which represents the TER.
The lower the percentage, the better the TER and the less fees affect the yield from the fund.
Investment manager Christopher Traulsen, of Morningstar, has compared the average fees and performance of more than 440 in Morningstar’s Sterling funds.
TER highs and lows
For the three and five-year periods ending August 31, 2012, each Morningstar bond was included in one of five league tables, with the average TER run for each section.
The results revealed the best-performing quintile of bond funds for the categories under review displayed the lowest average TER of 0.67%, the worst-performing section displayed the highest average TER of 1.05%.
Regular investors will be aware of fund fees and how they can dilute returns, but low yields in the bond market mean fixed-income investors must review how fees affect their returns.
Even in good markets, fixed income fund fees can be high, and beating fixed-interest benchmarks and the relatively compact spread of returns in fixed-interest sectors difficult. These factors are more important when yields are reduceed.
Traulsen said: “Time and time again, our research shows that fees are one of the most predictive factors in determining a fund’s likely outperformance. Even in the best of times, the impact of fees on fixed income funds is especially high, given the relative difficulty in beating fixed-interest benchmarks and the relatively compact spread of returns in fixed-interest sectors.
Don’t follow a manager
“In today’s low-yield environment, these factors loom all the larger. The unavoidable implication from our research is that investors would be extremely remiss not to focus on costs as a key criterion when selecting a fixed interest fund.”
“The unavoidable implication is that investors would be extremely remiss not to focus on costs as a key criterion when selecting a fixed-interest fund. It should by no means be the sole criterion, but investors must keep in mind that the higher the fees, the harder it will be for a manager to outperform. Some managers can be worth paying up for, but these are few and far between.
“Further, managers come and go whilst fee levels tend to be stable so investors electing to pay up for a given manager are relying on an inherently unstable element to compensate for a structural deficit, which is usually unwise”
