This week's chart of the week comes from Morningstar Manager Research's report, Predictive Power of Fees in Australia, Why Managed Fund Fees Are So Important. Liem Nguyen, Analyst, Manager Research, looks at why cost is a key consideration for investors and puts forward the data to demonstrate his point.

The study split fund share classes into fee quintiles based on grouping the funds on style factors for equity funds and geography for bond funds. Liem looked at the relationship between the average total returns and average fees across the quintiles of these categories for the five years ended June 2024. For each quintile a success ratio was calculated, which indicates the percentage of share classes that survived and outperformed their Morningstar Category peers.

Low costs are key to success

Across most categories that were examined as part of this study, the cheapest quintile achieved a higher success ratio than the most expensive fee quintile, illustrating the power of fees. As an example, in the global large-cap equity group, the cheapest quintile recorded a success ratio of 60%, while the priciest option recorded 23%. A similar trend was seen in the Australian large-cap equity group (55% versus 20%). The categories contained a significant number of passive funds in the cheapest quintile.

Recent years have been a challenging time for active managers to beat their passive peers as returns have been dominated by a select few sectors. Globally, technology companies have had stellar performances, with sector exposure growing from 16% to 24% of the global index. The catalyst is the promising potential growth of artificial intelligence. Locally, large banks have been beneficiaries from the rising interest-rate regime. These factors did not help active equity managers who aim to produce returns above the benchmark through diversified portfolios.

An outlier where the power of fees has shown no benefit is the Australian mid/small-cap equity group. The success ratio of the cheapest and priciest quintile is equal at 28%. The cheapest quintile’s low success ratio is attributed to consistent missteps in stock selection by active managers, as measured using the information ratio.

Liem adds a pertinent disclaimer, that investors should not just look at fees when evaluating funds. Qualitative factors such as the investment team, investment process, and parent organisation are also vital when determining a fund's outperformance potential. Still, lower-cost funds generally have a greater chance of outperforming their more expensive peers.

You are able to find the full report and analysis on Morningstar Investor (a subscription or a four-week free trial, is required).

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