Why managers will have to work harder
If the head of one leading United States asset management firm is right, the mutual funds industry will be forced to reduce costs and become more consumer-centric or risk decline.
John Bogle, legendary founder of the Vanguard Group and index fund pioneer, last month warned that fund companies would no longer get away with taking the substantial share of returns they have been used to in the past. They must cut costs or continue to lose investor trust.
Those familiar with Mr Bogle's lifelong campaign against excessive fund fees will also be familiar with his arguments; he has after all been banging this drum for more than 50 years, as he reminded the audience at a securities conference in Atlanta. This time, however, his message had particular resonance for an industry emerging from one of its darkest periods in history.
The past few years have seen the fund industry transformed from a sector trusted with the savings of millions, to something of a pariah. On top of bursting bubbles and a protracted bear market which have hammered returns, it has been hit by fee and brokerage scandals resulting in investigations, lawsuits and new legislation. The rot revealed, observed Mr Bogle, was not caused by just a few bad apples but a whole barrel of them.
It was not surprising that the industry - or its representatives at the Sibos conference - seemed ready for a bit of introspection. And Mr Bogle's advice for those looking to win back trust from investors was to start with fees.
The numbers are also starting to back his argument. Mutual fund costs average 3 per cent of turnover a year, said Mr Bogle. This level of cost may have gone unnoticed during the prolonged bull market when returns were abundant. But times have changed and returns are likely to be more anaemic in coming years, averaging perhaps 6 per cent. Take into account inflation and it is clear that unless fund companies are willing and able to cut their costs, there could be little by way of returns left over for investors.
According to Mr Bogle, fund houses have been too focused on their own returns and managers, an attitude which led to spiralling cost taking up an increasingly high proportion of returns. In future, companies will have to put the consumer first and pass a greater portion of returns to investors.
'We need governance reforms in mutual funds and reforms to ensure that investors get their fair share of whatever returns these markets achieve,' he said. 'Taking cost out of the mutual fund industry is essential.'
Mr Bogle is no longer a lone voice speaking out against high fees; they have been the subject of intense scrutiny in the United States. Four years ago a Securities and Exchange Commission (SEC) report concluded that during a 20-year period which saw assets under management in the US fund industry increase by 4,900 per cent to US$6.8 trillion in 1999, mutual fund expense ratios also rose steadily. Economies of scale were simply not passed on to investors.
More recent evidence came last year from a report by congressional investigators. They found that mutual fund fees were still on the rise.
'Fees and expenses, in fact, are going up,' said Representative Michael Oxley, chairman of the House Financial Services Committee, adding that many are 'hidden or opaque, escaping the attention of even savvy fund investors'.
Fund house executives in Asia may take comfort from the fact that Mr Bogle is far away and that Asian investors are more concerned with finding last month's best performing fund than hidden fees. But such complacency won't last long. Fund investors are growing increasingly knowledgeable and, in an environment of rising property prices and rising interest rates, managers will have to work harder to attract investment.
If funds are to continue to provide competitive returns, their providers are going to have to take Mr Bogle's advice and cut costs.
A good place to start would be to actually tell investors how much they are paying in fees. Publishing a total expense ratio or TER (a fund's total expenses divided by its average net assets) is obligatory in some markets, but not in Hong Kong.
Consumers must also be more aware of the impact of high fees on returns. A 1 per cent increase in a fund's annual expenses can reduce an investor's final balance by 18 per cent over 20 years.
Compare fees on different products (there are plenty of online fund return calculators available) and, in choosing between comparative products, opt for the one with the lowest fees.
Another abomination is that we still have to buy funds with a 5 per cent front-end load, which generally goes to the distributor. Add that to the annual management fees and you begin to see Mr Bogle's point. Elsewhere, loaded funds are going the way of the dodo but here only a couple of companies - namely Manulife and First State - have defied distributors and dropped the load.
Investors opting for loaded funds should always ask for a discount. Competition is such that even the biggest distributor will knock off a few per cent or more to get your business.