While the active vs passive debate continues to run on, one trend that has emerged in recent years has been the increasing preference for low-cost investment products.
Indeed, research by passive fund giant Vanguard found that “investors increasingly vote with their feet on investment costs”, a trend that has been witnessed over the past 15 years.
Investors have displayed a “striking preference for low-cost funds over high-cost funds” in both actively managed funds and index funds, according to Vanguard.
The study concluded that “cost is among the biggest enemies of successful investing”.
“A significant body of research suggests that not only is high cost a major impediment to success, but low cost is actually the best predictor of future outperformance,” the firm noted.
Among US equity funds and exchange-traded funds (ETFs), products in the lowest cost quartile (with a median expense ratio of 0.21 per cent) garnered $1.3trn in assets between 2008 and 2013. Products in the other three quartiles all experienced outflows during the same period.
Source: Vanguard
A similar trend was evident among bond strategies, where nearly all net cash flows over the 15-year period went into lower-cost options.
US bond funds and ETFs with the lowest-quartile expense ratios received around $1.5trn of inflows. Funds in the second quartile gathered just $110bn, while the two quartiles of funds with higher expense ratios suffered net outflows.
As such, Vanguard said there were potential lessons for investors in Europe, where there is greater awareness of costs amid changing regulatory regimes designed to get better value for investors.
The investment professionals we spoke to recognise the significance of the long-term impact of cost on investment.
“There is clearly pressure in the market for fee reduction across all parts of the investment journey, from products to advice,” said Victoria Hasler, director of research and consulting at Square Mile Investment Consulting and Research.
Passive funds have certainly benefitted from this trend, she added, and will probably continue to do so for some time.
“For many investors cost is paramount, and in an environment where there has been very little alpha available in markets over the last few years, it is not hard to see why.”
However, she sees opportunities ahead for active investors.
“Were we to enter an environment where volatility picked up, and other risks – such as liquidity – come to the fore, the focus may shift back from cost to value,” said the Square Mile research director.
While one should not overpay for beta, Hasler said, there is certainly an argument that alpha is worth paying active fees for.
Yet, for Darius McDermott, managing director of Chelsea Financial Services, there has been too much focus on cost.
“I agree it is important, but it is not the only factor,” he explained. “I worry that cost becomes the only think investors worry about.”
McDermott said costs are getting lower in all parts of the market “and this is a great thing but, again, not the only thing”.
The changes in regulation have accelerated the trend towards lower-cost options, said Adrian Lowcock, head of personal investing at Willis Owen.
“Particularly RDR [the Retail Distribution Review], which impacted how financial advisers charge and how clients paid for advisers charged and how clients paid for advice,” he said.
“This leads to some investors leaving and going for a DIY [do it yourself] option and advisers looking for low cost solutions for their remaining clients,” Lowcock said.
Source: Investment Association
As the above chart shows, post-RDR there has been a significant pick-up in the amount of flows into low-cost passive strategies
In addition, there has been an increase in short-termism among investors fuelling support for cheaper, passive products.
“It is harder for active managers to demonstrate value when the focus is often on short term performance,” he explained. “Passives can point to cost; and they have successfully marketed this message to investors.”
Nevertheless, cost is a false target, he argued, as a good active manager should be more than able to justify their costs.
“The issue is and should be value for money, cost is of course a factor for that,” he added. “The most important factors are getting investments that help meet your objectives and attitudes to risk.”
While passives have been getting cheaper, he said, they have probably hit a level now and that the next stage of the active/passive battle might see active funds begin to compete.
“Active funds haven’t really competed on price but I expect this to change over time as interest in passives hasn’t slowed down,” he said.
One of the reasons investors are choosing cheaper passive funds, said James Klempster, director of investment management at Momentum Global Investment Management (pictured), is the prevalence of so-called closet trackers. 
“One of the main areas that we have seen price pressure is for providers who have created purportedly active vehicles that have not provided excess return compared to passive funds,” he said.
“This should not be a surprise in the sense that if a fund is not, in essence, superior to a passive vehicle then it makes no sense to pay up for it.”
However, superiority may not simply be about returns, he pointed out.
“Often active managers are better at risk management, for example, which, depending on client preference, and which may be worth paying up for,” Klempster explained.
It is true that many active managers underperform their passive counterparts, the Momentum manager admitted; however a healthy proportion of active managers do outperform, he said.
“As a result, if investors want the potential for outperformance, they should consider paying above passive costs for it,” he said.
In time, Klempster sees a slackening of the price war.
“My experience suggests that some of the acute focus on prices has waned in the past year or so,” he said. “Perhaps that is because those that are left with active managers place a greater value on their potential benefits over the benefits of low-cost passives.”