Fixed income funds bucking managed fund fee trends

Research by Morningstar has found fixed income funds are bucking a general trend around managed fund fee dispersion with a smaller fee dispersion compared to equity ones. 

In a report The Predictive Power of Fees: Why Managed Fund Fees are so Important, the research house detailed how low-cost funds typically have a greater chance of outperforming their expensive peers. 

A test was conducted by grouping similar funds and splitting them into fee quintiles, and concentrating on core asset classes selected by Australian investors. Then it assessed the relationship between the average total returns and average fees across the quintiles of these categories for the five years ended June 2024. Finally, Morningstar calculated a success ratio which indicated the percentage of share classes that outperformed their Morningstar category peers. 

Across most sectors, the cheapest quintile achieved a higher success ratio than the most expensive fee quintile, illustrating the power of fees. For example, in the global large-cap equity group, the cheapest quintile recorded a success ratio of 60 per cent, while the priciest option recorded 23 per cent.

However, in fixed income, the dispersion was smaller and the cheapest quintile’s success ratio was 38 per cent and the most expensive quintile success ratio was 14 per cent. 

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“Our analysis suggests that although active fixed-income managers are often able to outperform the index gross of fees, the outperformance does not always compensate for the corresponding fees,” Morningstar said. 

“Over the tested period, active managers have been able to capitalise on the rising interest-rate environment by shifting their portfolios to shorter-duration positions – a lever unavailable to passive funds. Similarly, they have been able to adjust their credit risk exposure, benefiting more from a tightening in credit spreads than their passive peers. 

“Taking a longer-term view, active fixed-income managers can produce stronger returns over the economic cycle owing to a consistent overweight in corporate credit relative to the index. This is particularly evident within Australian fixed interest, where the conventional benchmark has a considerable skew – around 90 per cent – to government and government-related issuance.

“Thus, active managers tend to underperform the index in risk-off conditions while outperforming in more sanguine markets. Being compensated for the additional risk with higher yields tends to bolster index-relative performance through the cycle.”

Commenting on the findings, Morningstar analyst Liem Nguyen said: “This is not to say that investors should only 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.”