Although intuitively a key advantage of giant funds should be the ability to keep overall costs low and allow investors to benefit from the economies of scale generated, this isn’t always the case.
Indeed, often those funds with a large amount of assets under management don’t get cheaper the bigger they get.
The ongoing charges figure (OCF) investors must pay for active strategies has become the standard way to compare the cost of different funds, although it can vary depending on various factors.
The OCF has two elements: it is the sum of the annual management charge and other additional expenses –which include the cost of the custodian, the cost of producing reporting accounts and fees such as the audit fee or the Financial Conduct Authority fee.
Some strategies may also charge performance fees, which, although not that common, investors will have to pay on top of the OCF.
Although these charges will vary depending on strategies and fund houses, when a new active vehicle is launched, it starts by being very expensive. Then, as it grows in assets, it starts to get cheaper.
When a fund reaches a certain size, it plateaus. From that point, no matter how much the assets under management grow or how big it gets, the fund won’t get any cheaper.
As the FCA’s Asset Management Market study found in June 2017, economies of scale can arise at the fund level or at the firm level, both of which may benefit the asset manager.
But the extent to which investors benefit, the study concluded, depends on the extent to which any economies of scale are passed on from the manager to investors.
At a fund level, the study found that asset managers tend to benefit from economies of scale which, do not seem to be passed on fully to investors.
Indeed, as Charles Stanley Direct pensions and investments analyst Rob Morgan (pictured) explains, the annual management charge taken is a percentage that “stays the same no matter how big the fund is”.
“Fixed costs reduce as a proportion as a fund gets bigger, which leads to a lower OCF. However, for large funds getting larger, this effect is at the margin,” he explained.
According to Adrian Lowcock, head of personal investing at Willis Owen, the only driving force behind funds getting cheaper currently is a drop in prices by a fund’s competitor.
“In the passive space, a price war has led to funds getting cheaper and, whilst size means the big groups can drive prices down, price is really the only differentiator between tracker funds – if you assume they are all good on tracking error,” Lowcock explained.
In the active space, however, Lowcock (pictured) noted there are many differences between the products, with investors ending up buying the manager behind the fund, not just the fund itself. 
As a result, investors who are wedded to a particular manager have a fairly limited choice.
And, he added, there is greater competition in pricing for active managers in the institutional space, where large investors have much more influence because of the substantial sums of money involved.
But, should funds get cheaper as they get bigger?
AJ Bell’s head of active portfolios Ryan Hughes believes funds should pass on the benefits of their growth to investors.
Given how controversial the topic is, and the pressure some asset managers face to lower their fees, Charles Stanley Direct’s Morgan noted that reducing the fees investors pay for larger funds would be a way for fund management groups to differentiate themselves from their peers.
In Lowcock’s view, whether the prices should be regulated or whether the market should be left to govern itself is one of the biggest challenges, and a difficult question to answer.
“This is a tough one, as a free market should be better, but clearly prices have been fairly similar across the board,” the Willis Owen head of personal investing said. “I think, however, that we are seeing change as cheaper passives chip away at the active market. Also, in multi-asset price is a big factor in winning new accounts from IFAs.
“The issue is that by reducing prices too fair might lead to lack on new entrants and a loss of boutiques which I think would be detrimental in the long run. Price is important but not everything, likewise size doesn’t make a fund manager better.”
Hughes also noted investors’ increasing focus on fund charges may be a problem for smaller funds wanting to attract more assets.
“Because everyone is focused on charges, they naturally filter out the more expensive funds and, the trouble you have is that a new fund is usually expensive because they haven’t got a lot of assets,” he explained.
“How does it get bigger to get cheaper? Someone has to be brave and invest early to get the fund size up.”
In order to avoid this problem, a strategy adopted by many fund groups consists on implementing different approaches to how they grow a fund.
“Many fund houses, have new fund launches with founder share classes that are very cheap to encourage you to come in early,” said Hughes.
“That may be forever and that may be for a period of time and is an initiative that has been successful for some fund groups.”
One example, he said, is the £330m Montanaro UK Income, launched by the independent small boutique Montanaro Asset Management in 2012.
“When they launched the fund, it was very small, and they wanted to grow it,” he said. “To do so, they created a share class which had a cost of around 0.25 per cent and they said: ‘Anyone that invests in that share class will have that fee for life, and when it gets to around £200m that share class will be closed.
Performance of fund vs sector and benchmark over 3yrs
Source: FE Analytics
“Once the fund had reached the £200m size, new investors would have to pay the standard fee of 0.85 per cent. People looked at it and said: ‘it’s a good fund, it’s well-managed, incredibly cheap and I can lock it in for life’.
“As a result of that strategy, that £200m filed up reasonably quickly and now you have to pay the more expensive fee,” Hughes explained.
He added: “This is a good initiative to try to get small funds off the ground. At the end of the day, if it’s a rubbish fund it doesn’t matter because no one is going to buy it, you can give it away. But, when it’s a good product and you do that, you can get some traction.”