Hong Kong received a “below average” grade for its mutual fund costs, because of high asset-weighted median fees, especially for available-for-sale (external) equity and fixed-income funds, as well as the pervasiveness of front loads and trailing commissions, according to the first instalment of Morningstar’s biennial Global Investor Experience (GIE) report, released on Wednesday.
Fees matter, not just on a relative basis, but because they affect fund performance. As Morningstar found in a 2016 study, “the expense ratio is the most proven predictor of future returns” for any fund.
“Banks charge a front load subscription fees and receive an annual trailing commissions, or retrocession, paid out of the asset manager’s management fee – which, of course, is ultimately paid by the investors,” Germaine Share, associate director, manager research of Morningstar Investment Management Asia, told FSA.
More than 85% of funds, whether domiciled or available for sale in Hong Kong, report charging front loads. Funds with no loads are accessible to Hong Kong-based investors, but make up a small part of retail investors’ assets.
Funds without trail commissions are technically registered for sale in Hong Kong, but are not actually accessible to the average retail investor given that fund distribution is dominated by intermediaries, notably banks, according to the report, which grades the experiences of mutual fund investors in 26 markets across North America, Europe, Asia, and Africa.
“The concentration of distributors in Hong Kong presents challenges for asset managers in trailer fee negotiations, and it is common for trailer fees to make up as much as 50% of a fund’s management fees,” said Share.
“The funds industry in Hong Kong – and in Asia in general – is so driven and controlled by banks, that asset management firms have little negotiating power,” said Share.
Asset-weighted median fees charged in Asian jurisdictions
|**External allocation||Domestic equity||External equity||Domestic FI||
Source: Morningstar. *Domestic = locally domiciled; **External = available-for-sale.
On the other hand, global asset managers also have clear incentives to promote the funds that charge the highest fees.
Ucits funds make up the majority of the available-for-sale universe in Hong Kong and tend to be more expensive than locally domiciled funds. Overall, the asset-weighted medians for allocation, equity, and fixed-income funds available for sale in Hong Kong are 1.62%, 1.89%, and 1.41%, respectively.
“Locally domiciled funds are cheaper but tend to be smaller, and one reason why fees are higher for available-for-sale funds is that global asset managers, for obvious reasons, prefer to export their more expensive funds,” said Share.
Taiwan hits bottom
This is particularly evident in Taiwan, where the apparent complexity of high yield and emerging market bond funds can be used to justify bigger fees and encourages high-charging fund launches.
These high expenses, a fund industry structure that perpetuates the use of initial charges and retrocessions, and excessive new fund launches that include many expensive funds drive Taiwan’s “bottom grade”, according to the report.
Indeed, “Taiwan is a persistent poor performer in regards to fees and expenses, with some of the costliest funds among markets covered in the study,” said Share.
Elsewhere in Asia, Singapore was graded “below average” due to the “use of front loads, limited availability of retrocession-free share classes, and several high asset weighted medians, according to the report.
In contrast, Thailand was graded “above average”, one notch below the “top” classification, due to low asset-weighted medians, which are probably caused by the dominance of domestic asset managers in the industry.
Fee reduction measures
However, the price-setting power of a coterie of bank distributers is a common feature of the Asia funds environment.
There are several ways that pressure could be brought on them to reduce their fees.
Regulators could follow the examples of Australia and ban front load fees altogether, or like the Netherlands and the UK, insist that all fees are unbundled so potential buyers of the funds can clearly see what they are paying for and to whom. Top grades in the survey went to Australia, the Netherlands and the U, where regulators have forced greater fee transparency.
“In fact, regulators in Hong Kong and Taiwan have already introduced measures to improve commission transparency so that investors can compare fund costs more accurately,” Share told FSA.
For instance, since November 2018, Hong Kong’s Securities and Futures Commission (SFC) of Hong Kong has enhanced point-of-sale disclosure by requiring intermediaries to disclose the maximum percentage of trailer fees received for a particular fund per the distribution agreement and to make a one-time disclosure on whether the intermediary is “independent.”
However, it is unlikely that regulators in Asia is prepared to force more drastic changes on the banks in the current economic environment,” said Share.
“But, investors need to understand how significant fees are to a fund’s performance and they should be able to make direct like-for-like cost comparisons between the funds offered by the banks,” she added.
Online “supermarkets” are often touted as a competitive force that will force fees lower, and many have gained popularity in China and Thailand.
“However, most still have retrocession charges, so they are not necessarily cheaper alternatives,” said Share.
Global Fees and Expenses Scorecard