The research compared the performance of funds that are bottom decile for cost against those that are top decile, and found that the cheaper funds come out on top over three- and five-year periods in almost every equity, bond and multi-asset sector.
All trackers and institutionally focused funds were discounted from the results, as were the specialist sectors.
One of the best examples of the trend is in the popular IMA UK Equity Income sector.
According to FE data, the average bottom-decile fund for cost has returned 46.77 per cent over the last five years, almost tripling the returns of those that are top decile.
Performance of portfolios vs sector over 5yrs
Source: FE Analytics
The cheaper funds have also considerably outperformed their sector average over that time, while the more expensive vehicles have fallen short by more than 10 percentage points.
The margin of outperformance is smaller over three years, but still significant: the cheaper portfolio has returned 46.29 per cent over this period, compared with 30 per cent from the more expensive one.
UK Equity Income funds with a lower TER also have a considerably lower annualised volatility than the more expensive funds over both of these periods.
Among the list of cheap funds is FE Alpha Manager Francis Brooke’s Trojan Income, as well as PFS Chelverton UK Equity Income. They have a TER of 1.05 and 1.25 per cent, respectively.
Notable funds in the expensive list are Neil Woodford’s SJP UK High Income, which has a TER of 1.84 per cent, and Standard Life UK Equity Income Unconstrained, which has a TER of 1.91 per cent.
Cheaper funds also came out on top in the IMA UK All Companies, Global, Asia Pacific ex Japan, North American and various bond and multi-asset sectors.
Performance of portfolios over 5-yrs
| Name | 3yrs (%) | 5yrs (%) |
|---|---|---|
| Cheap UK All Companies funds | 36.06 | 30.24 |
| Expensive UK All Companies funds | 31.69 | 20.6 |
| Cheap Global funds | 30.62 | 29.89 |
| Expensive Global funds | 25.45 | 20.72 |
| Cheap Asia Pac funds | 34.08 | 44.23 |
| Expensive Asia Pac funds | 31.93 | 36.54 |
| Cheap Strategic Bond funds | 23.4 | 32.04 |
| Expensive Strategic Bond funds | 15.34 | 24.54 |
| Cheap Mixed 20-60% funds | 23.05 | 25.37 |
| Expensive Mixed 20-60% funds | 15.21 | 14.76 |
Source: FE Analytics
Whitechurch’s Ben Willis says he is not surprised by the results, as higher costs erode returns – particularly over the long-term. However, he believes it would be wrong to automatically dismiss expensive funds.
"It’s very interesting to see and it shows that the more expensive a fund’s TER, the more this drags on its performance," he said. "Obviously, there are going to be more experienced managers who have traditionally performed well – they might have higher TERs but have managed to negate that expense by beating their peer group."
"For instance, Richard Buxton’s funds' TERs are usually quite expensive but I would expect him to perform very well over five years."
Schroder UK Alpha Plus’ TER of 1.66 per cent is above that of the sector average. However, the fund has been a top-quartile performer in its IMA UK All Companies sector over three, five and 10 years.
"The most I would be prepared to put up for a fund, the absolute maxim, is around 1.5 per cent," Willis added.
"I would only break that rule if I were buying a manager who has posted consistent and stellar returns over a long period of time – such as Nigel Thomas. He is the type of manager who has outperformed over almost every time period."
The five crown-rated AXA Framlington UK Select Opportunities fund has a TER of 1.55 per cent.
Like Buxton’s portfolio, it has been a top-quartile performer in IMA UK All Companies over three, five and 10 years.
The only sector where expensive funds consistently come out on top is in IMA UK Smaller Companies – an area of the market that requires greater research than those with a larger cap focus such as IMA UK Equity Income.
Performance of portfolios vs sector over 5-yrs
| Name | 3yrs (%) | 5yrs (%) |
|---|---|---|
| Cheap UK Smaller Cos funds | 56.45 | 48.61 |
| Expensive UK Smaller Cos funds | 61.03 | 57.31 |
Source: FE Analytics
The five crown-rated Fidelity UK Smaller Companies and Old Mutual Dublin UK Select Smaller Companies funds are both in the top decile for cost. They have a TER of 1.72 and 1.94 per cent respectively.