Morningstar’s best research on fees
Our best insights from our research teams.
Sometimes it’s difficult to drown out the noise. There’s constant chatter about the ideal way to invest. Self-interested fund managers tout the superiority of their approach. Your mates at the barbeque will compare their results favourably to Warren Buffett while confidently proclaiming the next winner. The media will wheel out a revolving list of top performers in an ever-changing list of categories.
How do you come up with the right path to follow when there’s so many opinions?
Sometimes, it’s easiest to go back to basics. Learn from the past to inform your future decisions the most objective way you can – through data.
Below you can find some of the best insights that Morningstar has on fees.
The most reliable predictor of success
Our first insight is 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 by group. Style factors were used for grouping for equity funds and geography for bond funds. Liem looked at the relationship between the average total returns and average fees across the quintiles 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.
Across most of the study categories, the cheapest quintile achieved a higher success ratio than the most expensive fee quintile. The relative success ratios illustrate 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 cheapest categories contained a significant number of passive funds.
Recent years have been a challenging time for active managers to beat their passive peers as overall returns were driven by a select number of sectors. Globally, technology companies outperformed, with sector exposure growing from 16% to 24% of the global index. Locally, large banks have been beneficiaries from the rising interest rate regime. Active managers needed to be overweight these sectors to succeed.
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.
Don’t get caught up in the race to the bottom
One of Morningstar’s longest-running pieces of research is the Annual Fund Fee Study in the United States. While the data is US-based, the trends are relevant globally because they illustrate one of the biggest structural shifts in investing over the past two decades.
The study shows that investors have steadily paid less for investment management over time. Competition between fund managers, the growth of passive investing, greater transparency and increasing fee awareness have all contributed to lower costs.
One of the most interesting findings is that investors themselves have helped accelerate this trend. Rather than simply accepting whatever fee was charged, investors have consistently directed new money towards lower-cost funds. The cheapest funds have attracted the overwhelming majority of net inflows, forcing the broader industry to become more competitive. The result has been billions of dollars in annual fee savings for investors.
This is an important reminder that while markets are unpredictable, costs are one variable investors can control. Every dollar saved in fees remains invested and continues compounding over time.
Similarly, Morningstar’s Global Investor Experience Report compares investment markets around the world, evaluating areas such as regulation, disclosure, governance and costs. One of Australia’s strengths is with fees as one of the world’s most competitive markets in the study.
Compared with many overseas markets, Australian investors generally have access to relatively low-cost managed funds. Regulatory reforms over the past decade have significantly improved transparency around fees while increasing competition among investment providers.
The Future of Financial Advice reforms fundamentally changed how financial advice is paid for by removing many conflicted remuneration arrangements. At the same time, the rapid growth of exchange-traded funds (ETFs) has increased competition across almost every major asset class, similar to the results shown in the US through the fund fee study.
This has created a much healthier environment for investors. That does not mean every Australian fund represents good value. Fees still vary significantly between products, particularly among actively managed funds. However, investors today generally have access to a broader range of lower-cost, higher-quality investment options than ever before.
The lesson is that investors should not assume high fees are simply the price of accessing quality investment management. Increasing competition means there are now excellent investment options available across a wide range of price points.
What is important to remember is that this race to the bottom often means there will be a cheaper option just around the corner. Be careful to avoid temptation to ‘over-optimise’ your portfolio. Switching in and out of investments in search of the most efficient option can often cost more over the short and long run with the incurred transaction and tax costs.
There are places where paying more may be worthwhile
One misconception about Morningstar’s research is that it always advocates choosing the cheapest available fund. It doesn’t, and that demonstrated through the results in Morningstar’s Active Passive Barometer report.
Morningstar’s research examining where active managers add value demonstrates that the answer depends on the market. In highly efficient markets such as Australian large-cap equities and US large-cap equities, active managers have historically found it difficult to consistently outperform after fees. Information is widely available, competition is intense and identifying mispriced securities is challenging.
In these areas, low-cost passive investing often represents a sensible starting point. However, the picture changes in less efficient markets. Active managers have historically demonstrated stronger results in areas such as small-cap equities, emerging markets and certain fixed income sectors.
These markets tend to receive less analyst coverage, have lower liquidity and / or involve more complex securities. These attributes provide skilled managers with greater opportunities to generate excess returns. This doesn’t mean every active manager will outperform. Rather, it suggests investors should be selective about where they choose to pay active management fees.
Instead of asking whether active or passive investing is universally better, a more useful question is whether a particular market provides sufficient opportunity for an active manager to justify their additional cost.
This leads to a more nuanced portfolio construction process, where investors combine passive strategies in highly efficient markets with carefully selected active managers in areas where the probability of adding value is higher.
The headline fee doesn’t tell the whole story
Another important contribution from Morningstar is our role in developing the Total Cost Ratio (TCR). Many investors naturally focus on a fund’s advertised management fee when comparing investments. However, this often understates the true cost of owning a fund.
The Total Cost Ratio attempts to capture the all-in cost by incorporating management fees, estimated performance fees, operational expenses and fixed dollar administration charges. This provides investors with a more realistic estimate of what they are likely to pay over the course of holding the investment.
Investors should avoid focusing exclusively on the headline management fee. In Australia, regulations (RG97) require investment managers to disclose an estimated total cost in their Product Disclosure Statement. Morningstar also provides a Total Cost Ratio for funds and ETFs on our website.
Review the total fee, including estimated costs, as it gives you a better idea of what you are paying for an investment over the headline management fee. Dig deeper to understand your true cost before committing.
The common thread
One message consistently emerges across Morningstar’s research. Costs matter because they are one of the few elements of investing that investors can control.
That doesn’t mean investors should blindly choose the cheapest fund available. . A good way to frame fees is ‘Am I receiving value for the fee I’m paying?”
Fees should never be considered in isolation. They are one part of a broader assessment that includes the quality of the investment process, the capability of the people making investment decisions and whether the expected value added to your portfolio goals is likely to exceed the costs.
