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September 3, 2018

Monday Morning Memo: Is it only about fees and expenses in the funds industry?

by Detlef Glow.

Fees and expenses in the mutual funds industry are a hot topic for investors and market observers around the world. In some cases discussions are going so far that one could get the impression that fees and expenses are the only criteria an investor should use when selecting a mutual fund or ETF. These discussions have recently been fueled by media coverage of the launches of some low-cost funds by large asset management groups.

Fees and expenses, especially for actively managed funds, have been under scrutiny for a while, since a large number of actively managed funds have not beaten their benchmarks. The fact that there is no guarantee that even the best fund manager will be able to deliver future outperformance makes the selection of an actively managed fund a bet against the market. In the best case the investor will be rewarded with outperformance. Therefore, it is key for the investor to balance the odds right.

I have even heard arguments that the unpredictability of the future performance pattern of a fund makes fees and expenses the main criteria for fund selection in a given segment. The investor does know what he will have to pay for the future performance and should therefore select the fund with the lowest total expense ratio (TER).

I partly agree with this thesis, especially pertaining to bond funds. We have witnessed in some cases fee levels that are so high they may lead to underperformance, since the fees and expenses are higher than the average return of the bonds held in the portfolio. That said, even in these cases a fund may be able to deliver an adequate return if the manager adroitly plays the duration and/or credit segments in combination with superb securities selection.

Don’t get me wrong here. I am not saying investors should pay any price for their funds. But they should not use fees and expenses as the primary criteria for selecting a fund. In other words, investors should be cost conscious and aware of the fees and expenses they pay to their fund manager, but fees and expenses should not overrule product quality or advanced performance analysis in a professional fund selection process.

The views expressed are the views of the author, not necessarily those of Refinitiv.

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