Investors are increasing being sent the unambiguous message that a critical way to improve their opportunities for investment success is to keep their costs to a minimum.
The reality is that the lower your costs, the greater your share of an investment’s return. Further, repeated research suggests that lower-cost investments have tended to outperform higher-cost alternatives over the short to long-term.
An area where investors can readily choose between lower-cost and higher-cost investments is funds management.
And interestingly, the lead article in the international Morningstar Magazine for August-September argues that a "singular quest" should unit investors in index funds and actively-managed funds: a determination to pay low fees.
In the aptly-titled feature United Against Fees, Morningstar’s director of global ETF research Ben Johnson emphasises how low fees can critically influence whether a managed fund is going to survive and succeed.
Johnson writes that Morningstar research examining the performance of a wide range of US managed funds over the 10 years to December 2014 shows: "Investors would have substantially improved their odds of success by favouring inexpensive funds, as evidenced in all but one category.
"On the flip side of the coin," he adds, "investors choosing funds from the highest-cost quartile of their respective categories reduced their chances of success in all cases."
Johnson bases much of his article on the Morningstar Active/Passive Barometer, a semi-annual report that measures the performance of US active managers against their passive peers within their respective Morningstar categories.
"The report is unique," he explains, "in the pragmatic way that it measures active-manager success. For example, it compares active managers’ returns against a composite made of relevant passive index funds."
In short, it measures the after-fee returns of active managers against the actual, after-fee performance of passive funds – rather than against a pre-fee benchmark.
The key findings of the Active/Passive Barometer include:
- Actively-managed funds have unperformed their passive counterparts, especially over the long-term. (In the context of fees alone, passive or index-tracking index funds are typically extremely low-cost products.)
- An examination of how the average dollar invested in various types of active funds has fared against a passive alternative shows the importance of fees.
- High-cost funds are more likely under-perform and to close or merge than low-cost funds.
The bottom-line is that whether investors are using traditional index funds and Exchange Traded Funds (ETFs), actively-managed funds or – as is increasing common – a blend of both, costs really matter. And, of course, the toll of high-cost investing really mounts over time.
To read more on the contribution of low costs to potential investment success, see Beyond the passive versus active debate, Smart Investing, August 19.
 |
Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment. |
|
