Why are some fees higher 

Fees can be higher dependent on the investment strategy. Fees on actively managed funds are typically higher across the board. There is also a larger difference between the minimum and maximum fees charged by an active fund compared with a passive fund [such as some Exchange Traded Funds].

Exhibit 1 below takes the Australian large blend Morningstar Category and shows that the average annual investment management fee for an actively managed fund is just over 1% compared with 0.38% for a passively managed fund. 

It also shows that the maximum investment management fee for an actively managed fund in this category can be up to around 4.22% per year due to the strategy being geared [using debt] or because of performance fees. 

The difference between active and passive investment management fee rates is largely due to the costs associated with investment research staff and, in some cases, what the manager thinks they charge based on past success or their distribution network. 

Exhibit 1: Fees of Active versus Passive Funds – Australian Large Blend Category

Source: Morningstar Direct: Data as at 31 December 2023; Data is based on the open-end and exchange traded funds universes including master trusts where administration fees are included. Data excludes the superannuation and pension universes.  
 

How fees vary

Investment management fees also tend to vary depending on the asset class — funds investing in fixed income are generally cheaper than those investing in equities, according to Morningstar data.

Let’s use the average investment management fees of passive funds in Morningstar’s Direct database to highlight how fee levels generally increase in line with the risk or complexity of the underlying investments (Exhibit 2, below). This difference in fees across asset classes is driven by numerous factors including the risk and complexity of the asset class, the liquidity of the underlying investments, and the number and type of underlying jurisdictions invested and for passive strategies, the licensing cost of the index being replicated. 

Exhibit 2: Average Passive Fund (including ETFs) Costs per Asset Class 

Source: Morningstar Direct: Data as at 31 December 2023. Data is based on the open-end and exchange traded funds universes including master trusts where administration fees are included. Data excludes the superannuation and pension universes.  

Fees matter, particularly as they are paid out of investor returns.  If investors get a lower return, their investment return is even lower after fees. 

Now, let’s look at two hypothetical funds to understand fully what a difference in high investment management fees can make to your return over 30 years (see Exhibit 3). In this example, it changes the final outcome by more than $87,000.

Exhibit 3: The Impact of Investment Management Fee on Returns 

Source: Morningstar

Are fees falling? 

The good news is that fees have been falling or, at least as Morningstar data has revealed, remained stable over time. Morningstar has seen this trend most notably in the Exchange Traded Fund (ETF) sector. 

At end of 2022, the asset weighted average cost of equity ETFs dropped from 0.50% per year to 0.24% over the past three calendar years [1]. Last year, a number of large ETF providers cut their fees not only due to their sheer economy of scale but also in a bid to increase market share. 

Assessing different fees 

It is crucial investors look under the hood when assessing fees as not all fees are the same. Indeed, there are myriad of such costs from performance fees, buy-sell spreads, brokerage, administration costs. 

As the name suggests, a performance fee is based on the performance of the fund and aims to align the interests of the manager and investors. It’s good in theory, but the devil is in the detail. The basic premise is that the manager needs to generate performance in excess of the hurdle, which is essentially a market index. 

For example, consider a managed fund that aims to beat its hurdle, the MSCI World Accumulation Index (AUD). If the fund manager beats this “hurdle”, they can then share the rewards with you. That is, you get 100% of the performance (after investment management fees) up to the hurdle rate, and then you pay the manager some of the performance they have generated over this rate. 

In theory, the more difficult the hurdle, the better for the investor, but note that setting hurdles too high might encourage the manager to take excessive risk in order to have a shot at earning a performance fee.

Most investors would be happy to pay these higher fees in exchange for this level of outperformance. But investors would clearly be better off with no performance fee component and the same strong returns, in Morningstar’s view.

Buy-sell-spreads are what the name suggests and are simply the transaction costs of trading securities, that is investors are charged for what they buy and sell,.

ETFs also charge administration costs which is the cost of running the ETF and includes listing fees. Generally, the larger the ETF, the lower the fees as some of these fees are fixed costs and so can be spread across a larger base. 

Finally, net investment returns are the key. In a world of unknown future returns, investment management fees are a certain deduction from your investment return. Fees can make a material difference to the ultimate outcome, so it definitely pays to be aware of them. 

Conclusion

There is no doubt that investment management fees are an important part of an investment decision. Investors can also use Morningstar’s Total Cost Ratio; it is a single figure encompassing the total nondiscretionary fees and costs associated with managing a fund in Australia. It includes investment management fees and costs, performance fee costs, and total annual dollar-based charges. Importantly it provides an investor with a figure quantifying the cost of investment across all types of investment products.

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[1] ETF Investor 2022

DISCLAIMER

The content is for educational purposes only and does not constitute financial advice.  Independent advice should be obtained from an Australian financial services licensee before making investment decisions.

Any general advice has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and provided without reference to your financial objectives, situation or needs. You should consider the advice in light of these matters and any relevant Product Disclosure Statement before making any decision to invest. To obtain advice for your own situation, contact a financial adviser. Past performance does not necessarily indicate a financial product’s future performance.