High investment fund fees can really cost you

We like to remind our readers that costs matter. You can't predict the return you'll make, or be sure of how the economic backdrop will affect your investments. But you can control what you pay to invest and every penny saved on costs is an extra penny compounding away in your retirement account. This week, another report arrived to hammer the point home. The European Securities and Markets Authority (ESMA) published its first annual report into the cost and performance of "retail investment products" (investment funds, in other words). ESMA, which is a European Union (EU) financial watchdog, looked at the performance of both active and passive funds across various EU states from 2008 to 2017.

When it comes to costs, ESMA found charges were highest for equity funds aimed at retail investors (averaging around 2% a year, although charges were higher in some nations than others), with bond funds coming in at a lower (though still steep) average of 1.4%. Those charges, roughly twice as much as those paid by insitutional investors, make a big difference "on average, taking out 25% of gross returns in the period from 2015 to 2017," reckons ESMA. The UK was slightly better than the average (which was dragged up by the likes of Spain and Portugal), but still pretty drastic at just below 20%. What's also surprising is that in contrast to the US, and despite the rapid growth in competition from cheaper passive alternatives average costs across Europe had not changed much between 2008 and 2017.

Less surprisingly, passive funds (those that simply track an index) were a good deal cheaper than active funds (those that employ a human manager to try to beat an index). As a result, the passive funds beat the active funds after fees. However, actively-managed equity funds provided a "slightly better gross performance" than their passive counterparts. In other words, the quest for "alpha" (added value over and above the market) is not entirely in vain. Active fund managers are capable of beating the market the trouble is they just charge too much for the privilege.

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What does it all add up to? If you want to invest in a specific market, then look for a cheap tracker fund if you want to keep things simple. If you are willing to do a bit more research in the hope of beating the market, then find an investment trust with a good track record. Trusts (not included in the ESMA study) have a better record of beating their benchmarks over longer periods of time than their unit trust rivals, and they are often cheaper too. Better yet, you can sometimes buy at a discount (ie, below the value of the trust's underlying portfolio).