Portfolio Dilemma: how much should I pay in fund fees?

Richard asks: I’ve been thinking about investing in active funds but worry about the fees they charge. How much should I expect to spend?

Fees are easily overlooked given that they can, on the face of it, seem like a small amount. 

A 1% fee, which might be considered fairly high on an active fund, still looks like a small price to pay, at least to the untrained eye.

However, this can have a big effect on your overall returns, given that those charges will keep eating into the money you get to keep.

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As such, it’s important to think about what fees are reasonable – and what other considerations to weigh up when picking a fund.

There’s no one-size-fits-all approach to charges but past research has shown that generalist equity funds (for example, a global or UK fund) might charge somewhere around the 0.75% mark. 

Many do go lower than this, however. The investment trust space, in particular, can see big names charging much lower amounts.

And generally speaking, a few factors might be expected to move that fee up, or down.

Factors that might justify, or at least explain a higher fee, include:

• The fund being smaller, and more expensive to run for the time being
• The fund focusing on niche areas that arguably require more research and expertise, such as private assets or smaller companies
• The fund being an especially strong performer – although this argument might be debatable

Conversely, we might expect a fund to lower its fees as it grows.

Some well-known names have been good at this, Look, for example, at Scottish Mortgage Ord (LSE:SMT), whose investment team charges a fee that comes to 0.33%.

Where to look and what to consider

Investors can find a fund’s fees on their monthly factsheets, while the cost disclosure document available on a fund’s instrument page on our website will set out other costs. 

This can include things such as transaction costs, which will vary over time but do make a difference to your overall return.

When judging a fund’s fee it can make sense to see what similar, rival funds charge. If a fairly mainstream fund charges a higher amount than very similar offerings, it’s worth asking whether they are justifying that.

Ultimately, one other big question is worth asking. 

Is the fund offering you something different and valuable, be that accessing a market in a specialist way, or delivering consistent outperformance?

What matters at the end of the day is performance after fees, and if a fund has a high charge but consistently delivers big returns then that might feel like a good deal.

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The same might be said for a fund that does a good job of protecting you from market volatility.

On another note, investors do want to be wary of funds that charge performance fees. 

Here they tend to take a decent cut of the fund’s excess returns versus a benchmark index, above a certain threshold. You may find similar funds that don’t apply such a level on extra returns.

There are a few cases where a fund decides not to charge an annual fee and instead only charges an outperformance fee, if it hits a certain target level of return. Fund houses like Orbis have stood out on this front.

This structure might be appealing, given that it should in theory incentivise a fund manager to show some conviction.

Passives

Tracker funds tend to be much cheaper thanks to a price war that is still ongoing. 

But again differences apply here. 

A fund tracking a mainstream equity market like the S&P 500 or FTSE 100 should be expected to charge less than 0.1%, while funds focused on more niche areas (such as smaller companies) will be more expensive.

Investors might also want to tread carefully when it comes to thematic exchange-traded funds (ETFs). 

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They target exciting investment areas but do sometimes come with much higher fees than a conventional tracker fund would.

It’s worth noting that we regularly update a piece setting out the cheapest ways to track different markets.

If you have a question you’d like to be considered in our Portfolio Dilemma series, we’d love to hear from you. Please contact: editorial@ii.co.uk