Passive equity funds leading the way with fee cuts, finds Morningstar

Oct 22nd, 2018 | By | Category: Equities

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Passive equity managers continue to lead the price war by cutting fund fees at a faster rate than their actively managed peers, according to a report from investment research house Morningstar.

Jose Garcia-Zarate, Associate Director, Manager Research at Morningstar

Jose Garcia-Zarate, Associate Director, Manager Research at Morningstar.

The research analysed the effects of the Retail Distribution Review (RDR) – a set of rules that were enforced in 2013 aimed at promoting greater transparency and fairness in the investment industry – on fund fees for UK investors.

It looked at a representative sample of funds available for sale in the UK including actively managed and passively managed open-end equity and fixed income funds.

The report notes that, despite starting from an already lower price point, passive equity funds cut fees by nearly a third (28%) since 2013, compared to less than a fifth for active equity funds (18%).

The biggest drops in fees were in passive funds investing in US equities, global emerging markets equities, and global large cap equities with fund fees in these categories falling by 50%, 37%, and 36%, respectively.

Fees have also come down in the fixed income funds space but to a lesser degree, with actively managed funds producing the largest cuts over the period – the average fee for actively managed bond funds fell by 10% since 2013, while passive fees fell by just 4%.

According to Morningstar, the contrast with the equity market is likely attributed to the slower pace at which passive providers have adopted fixed income products and the lack of competition in the market.

Within passive fixed income, the largest percentage falls in fees were attributable to funds investing in global government bonds (16%), local currency emerging market bonds (9%), and GBP-denominated government bonds (8%). Bucking the trend were funds offering exposure to global corporate bonds, increasing their asset-weighted fees by 11% since 2013.

Asset flows since RDR

In general, passive’s greater willingness to lower costs for investors has resulted in it claiming a greater proportion of market share since before the implementation of RDR. From just over a quarter of assets in 2013, passive now accounts for more than 40% of equity fund investments across the sample of funds surveyed. The trend was even more pronounced in fixed income, which went from an 80:20 split in favour of active to nearly 50:50.

Jose Garcia-Zarate, Associate Director, Manager Research at Morningstar, commented, “There is no doubt that the RDR has influenced the marketplace positively. There is greater transparency of fees for the investor and this has brought to the fore the issue of the assessment of value at a fund level.

“Passive funds have driven increased competition into the equity market resulting in a price war between active and passive funds, but the market still has further to go, particularly in fixed income.”

Despite the Financial Conduct Authority (FCA) issuing its final guidance on unbundling in April 2018, the report also showed the absence of a significant fall in assets in bundled share classes – those that include fees taken by advisers and platforms for their role in distribution. According to Morningstar, this raises a concern that financial advisers and asset managers alike will be slow to act in switching assets into clean share classes. They may wish to keep those legacy assets in bundled share classes for as long as possible, where their slice of the fees is obscured.

“Many investors remain in expensive bundled share classes, which are eating into their returns,” added Garcia-Zarate. “We hope that now the FCA has issued its guidance on the outstanding issues, those legacy assets can start to move to clean share classes, in the best interests of those investors.”

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