Why it doesn’t always pay to save money on cheaper funds

The top 10 performing UK funds over the last five years also have higher-than-average charges according to research conducted by Chelsea Financial Services.

This is in contrast to the increasing trend of investors switching out of higher fee funds in favour of cheaper alternatives such as passives.

Indeed, the Financial Conduct Authority (FCA) recently released a report revealing that investors will switch to cheaper funds when they are presented with a warning about the impact that fees and charges can have on their investments.

In its analysis on all the funds in the IA UK All Companies sector over a five-year performance period to the last quarter end, Chelsea Financial Services found that this may not be the best option.

According to the firm, the average UK equity fund has an OCF of 0.70 per cent. The results showed that the 10 best performing funds in the 238-strong sector have an ongoing charges figure (OCF) of higher than the average with four of these charging more than 1 per cent.

The research showed that after these higher charges were accounted for, the top performing funds would have returned between £5,500 to £8,500 more than the cheapest funds in the sector.

Old Mutual UK Dynamic Equity, which has an OCF of 1.07 per cent, was the best performing fund over the five-year period.

This was followed in the study by CFP SDL UK Buffettology Institutional and MFM Bowland, which have ongoing charges figures of 1.33 per cent and 0.90 per cent respectively with all three posting a total return of over 120 per cent in the five-year period.

Top 10 performing funds over five years and OCF

Source: FE Analytics

Darius McDermott, managing director of Chelsea Financial Services, said: “Buying the cheapest fund is not going to result in the best consumer outcome. Fund houses are now being given the opportunity to evidence how they add value for money, and it is essential that they get this right.

“A consistent way to show this value would be best, so that investors can easily assess the advantages and base their decisions on more than cost alone.”

Another finding in the analysis was that only three funds out of the 60 in the top quartile of the sector have an OCF of less than 0.70 per cent.

The first of these funds is the Montanaro UK Income fund, which ranked 22/238 and has an OCF of 0.35 per cent.

The fund returned 71.26 per cent over the five-year period and beat its benchmark – the IA UK Equity Income sector – by 30.31 per cent.

Next are two index trackers: iShares Mid Cap UK Equity Index (UK) with an OCF of 0.17 per cent and HSBC FSTE 250 Index with an OCF of 0.18 per cent, which both returned over 50 per cent in the same period.

However, more than half of the funds that returned bottom quartile performance figures over the five-year period have an OCF above 1 per cent.

McDermott said: “Could fund management costs be reduced further? Yes they could. And we have already seen a small number of companies take these steps – Baillie Gifford, for example.

“More companies could, and should, pass on their economies of scale to investors, but at the same time, investors need to understand that returns after charges are far more important than the level of fees alone.”