One of the most important decisions before investing is whether to invest in active managed funds or passive one’s.
During the past couple of years, it was statistically proven that passively managed investments (ETFs) attracted more positive flows whilst investors were cashing out from active manged funds. (see bar chart below).
The ultimate reason for this is due to the higher fees we as investors need to pay for active management. Rightly so, we would ask the question – Is it worthwhile paying an additional fee for something which we can easily attain by investing in an ETF and pay much less? Do fees damage performance so much or are we exaggerating?
In order for us to understand the effect of fees on performance, in this article I wanted to compare the same investments with each other but one of them having a higher fee.
Active Managed Fund vs Active Managed Fund – the fee differential!
Here I will be comparing the Russell US Equity Fund (CLASS A) with the Russell US Equity Fund (CLASS B). I am using two active managed funds, which are exactly the same but are of a different share class. This means that the management and underlying holdings are exactly the same – the only difference is the fee structure.
I am using active managed funds against each other (rather than ETF vs active fund like I did in another article) because the aim here is to understand the effect of fees on performance, whilst eliminating any other factors.
The A Class has an annual management fee of 0.87% whilst the B has an annual management fee of 1.72%.
As we can see from the above stats, as time passed, the difference between performance gets higher – don’t forget that we are comparing the same fund so the difference is just the fees!
Over one-year period, the difference in performance is 0.86% (3.37% minus 2.51%) which makes perfect sense since the difference in fees of the two funds is 0.85% (0.87% fee for class A minus 1.72% fee for class B)
Over a 5 year period, the A Class (lower fee) generated an annual return of 12.79% whilst the B Class (higher fee) generated 11.82%. We are now taking about 0.97% each year for 5 years!
The fee differential increased the more time passed and this is due to compounding interest. This can also be understood by just looking at the chart as the lines slowly more away from each other. Using the higher fee share class, we would be compounding a very small fraction less each day but that, at the end, will be considerable over the longer term.
Understanding the fee structure of the investments we pick is crucial. Although we know that active managed funds have higher fees however, it is important to also look beyond this as highlighted in my earlier article.
There are some instances that owning ETFs make more sense whereas there are cases whereby mutual funds are more appropriate. In webinar we discussed the differences between the two and how you can pick the best from both. Click here to watch for free!