Fees eroding risk premium: Researchers

Fees charged by fund managers may make it tough for some New Zealand investors to access an investment that pays a fair equity risk premium.

Friday, April 13th 2018, 6:00AM

by Susan Edmunds

AUT researchers have used market data back to 1899 to determine that a fair equity risk premium for New Zealand investors to expect over the long term is 4.76%.

That means that investors with money in equities should expect to have a return that is 4.76%per year higher than 10-year government bond yields.

They said using information over such a long period made their work more robust.

“Human expectations over the short term are volatile, it is only by using long-term data that we can truly see the view of investors return requirement of equity. Also, using long-term data allows one to be more confident on the future ERP from a statistical viewpoint.”

Head of the finance department and director of the Auckland Centre for Financial Research Bart Frijns said managers’ performance indicated that in the long run most NZ equities managed funds in New Zealand could be expected to deliver that premium.

But he said, from that, they were deducting fees – and some were too high. If a manager was charging 4% for an equity fund, that left little of the risk premium left for the investor.

He said that meant most fund investors were missing out on full compensation for the risk they were taking with their investments.

"I would argue that high fees in a fund make it hard to deliver the market risk premium net of fees, as fees directly eat into the return that can be delivered to investors. For instance, if the market delivers a risk premium of 5% and a fund charges 1.5% in fees, then the fund will have to make up for at least 1.5% in additional performance through active management to break even on what the market can (passively) deliver."

Some managers justified their fees by saying they should be able to deliver more of a return, he said, but the research had not shown that. “What we’ve seen in a lot of work we’ve done recently is there is no evidence of their ability to outperform.”

He previously completed KiwiSaver research that showed funds underperformed against a benchmark by the amount of fees they charged. “The criticism we got was that it was a down market and it’s hard to outperform the market in a down turn. Now it’s up and the argument is you can’t beat the market when it’s going up.”

Investors should look for an investment that would deliver the equity risk premium at minimal cost, he said.

Chris Douglas, director of manager ratings at Morningstar, said Frijns was right to raise concerns about some fees.

“Investors need to be taking a very hard look at any fund that charges more than 2% and ask themselves what they are getting for paying a premium like this. In many cases they are paying too much.”

Tags: equities fees