There is a big difference, however, between buying cheap funds and getting value for your money.
Indeed, all performance data on FE Trustnet is inclusive of costs unless otherwise stated.
Whatever the cynics say, not all of the charges levied by funds go into the pocket of managers and salesmen.
High quality research doesn’t come cheap, especially if you’re investing on an international basis or in specialist areas such as small caps.
Some cheap funds have given investors the best of both worlds, as highlighted in a number of articles on FE Trustnet in recent weeks, and plenty of expensive funds have failed to meet their objectives.
However, there are plenty of actively managed funds that have justified their above average costs in recent years, and arguably have an edge over their rivals.
Jupiter Merlin Income
The double layer of charges means that funds of funds tend to be more expensive than those that invest directly into stocks and shares.
Some are able to keep costs down by investing in funds under the same roof, while others – such as Robin McDonald and Marcus Brookes’ Schroder Diversity range – have made a conscious effort to lower their charges.
However, regardless of increasing competition in this area of investment, Jupiter Merlin is still the go-to team, and with good reason.
The FE Alpha Manager trio of John Chatfeild-Roberts (pictured), Algy Smith-Maxwell and Peter Lawery have a track record going back more than 15 years, and have delivered strong outperformance on both a consistent and cumulative basis.
The £4.6bn Jupiter Merlin Income fund is arguably the pick of the bunch.
As well as delivering top decile returns over a 10 year period with returns of over 140 per cent, the fund has beaten its sector average in 12 of the past 13 calendar years.
Performance of fund and sector over 15yrs
Source: FE Analytics
The fund, which is currently yielding 3 per cent, has also been one of the best from an income point of view, paying out over £5,000 worth of dividends over the past 10 years from an initial £10,000 investment.
Investors have to pay up for exposure to Chatfeild-Roberts and his team however, with Merlin Income currently levying clean ongoing charges of 1.4 per cent.
A handful of fund of funds have charges below the 1 per cent figure.
Cheaper funds such as Schroder MM Diversity are giving Jupiter Merlin’s growth focused funds a run for their money, but there is no standout rival to the income portfolio in the fund of funds space.
Rob Gleeson and his FE Research team believe the fund is worth the extra cost, including the fund in their FE Select 100 list.
They point out the team’s top down macro views have been correct more often than not, and like their no-nonsense approach of picking tried-and-tested managers with strong track records.
Funds run by Neil Woodford, Adrian Frost and Stuart Rhodes are all big positions in the portfolio.
“One downside to the fund-of-funds approach is the additional layer of charges, and the cost of the fund is high compared with many other mixed-asset portfolios,” they said.
“However, the strong returns have more than made up for this. The fund is best used as a single investment solution rather than as part of a portfolio and this further justifies the high charges.”
Lawery is set to stand down as co-manager at the end of this year.
R&M UK Equity Smaller Companies
Small caps are another higher cost area of investment. Managers operating in this sector have a much larger universe of stocks to choose from, which are covered by a much smaller pool of analysts.
Finding undiscovered gems is a higher possibility as a result, but this doesn’t come for free.
One fund that has caught the eye in recent years is the five-crown rated R&M UK Equity Smaller Companies fund, run by FE Alpha Manager Daniel Hanbury and former FE Alpha Manager Philip Rodrigs.
The fund has an OCF of 1 per cent, but given the calibre of managers on offer, Richard Romer-Lee and his team at Square Mile think it is well worth the cost, awarding it a AA-rating.
They like the fund’s quantitative approach to investing, which identifies quality companies with high returns on capital, steadily growing cash flows and robust business models with high barriers to entry.
“Hanbury is still only in the middle of his career and we believe that he has the experience and temperament required in a good fund manager,” the team said.
“He is ably assisted by Rodrigs who, in his relatively short career, has already built up an impressive reputation in uncovering rapidly growing businesses that generate impressive returns for investors.”
“R&M has developed a sophisticated quantitative system, designed to categorise and grade stocks, which is referred to by the team as 'MoneyPenny'.”
“Hanbury is one of the principal architects of the tool, which has been road-tested for many years and proved particularly useful in sifting through an extensive amount of data to highlight potential investment opportunities.”
“However, when considering an investment the team do like to meet with the company's management in order to fully understand its model and industry environment.”
R&M UK Equity Smaller Companies attempts to beat its Numis Smaller Companies (ex IT) benchmark by 3 percentage points on an annual basis, which it has done with ease since Hanbury started running it in July of last year.
Performance of fund, sector and index since July 2013
Source: FE Analytics
As well as running R&M UK Equity Unconstrained since 2007, Hanbury ran the Investec UK Smaller Companies fund between 2001 and 2006.
He run the small cap fund at R&M between 2006 and 2010, before taking it over again last summer.
FE data shows as a manager he has returned 167.45 per cent over a 10 year period, beating his peer group composite by more than 40 percentage points.
Three of the most popular funds in the IMA UK Smaller Companies – Fidelity UK Smaller Companies, Schroder UK Dynamic Smaller Companies and Standard Life UK Smaller Companies – are either closed or closing to new money.
However, the £381m R&M fund still has a lot of spare capacity.
Fidelity Emerging Europe Middle East & Africa
The travel and research costs associated with emerging markets are much higher than in developed markets – especially in more under-researched areas such as Africa and the Middle East.
One of the few funds that invests in this area is FE Alpha Manager Nick Price’s Fidelity Emerging Europe Middle East & Africa portfolio, which has an OCF of 1.31 per cent.
The FE Research team believe that allocating a small portion of a portfolio to a fund like this is a good diversification tool for a long-term investor. Economies in Africa in particular are among the highest growing in the market, and there is a strong case for having exposure to them – as long as you’re willing to invest for at least a decade.
The fund is one of the few with a sizeable weighting to Africa. Price prefers to get exposure to the continent via the relative safety of South Africa, which has a 51 per cent weighting.
Europe ex UK makes up a quarter of assets, with the Middle East and the rest of Africa accounting for 12 per cent. The rest is in international companies and cash.
Performance of fund and index since launch
Source: FE Analytics
Price has a bias towards quality companies, which has helped the fund protect more effectively against the downside than its peers.
It has also performed strongly in up markets, and unsurprisingly this has led it to strong outperformance versus its benchmark since it was launched in 2008. While the index has lost money, Price has made returns in excess of 40 per cent.
A major selection criterion is the return on assets, or how much profit is generated for each dollar of capital invested in a company – this must be high and sustainable.
The management’s reliability is assessed through its track record of paying dividends, as these impose discipline and demonstrate a shareholder-friendly attitude.
