The October 2014 Investment Insight from Segal Rogerscasey analyzed active U.S. equity managers to determine whether higher fees are indicative of above-average performance or a prelude to, or even a cause of, below-benchmark returns.
To test whether funds that charge higher fees outperform those with lower fees on a net basis, the firm applied two analytical techniques drawn from the testing of anomaly returns among equity securities: the cross-sectional decile spread method (spread portfolios) and the cross-sectional regression method (slope portfolios), For each year and style, spread portfolios and slope portfolios were calculated to measure the differences between high- and low-fee managers. The results of the individual styles were averaged over all years to get a single average for each style. These were then averaged across styles to obtain an overall single numeric result.
On an aggregate basis, higher-fee funds underperformed lower-fee funds. The analysis found this to be true for every asset category and style box combination but one.
“At the end of the day, price or fees matter, and they can particularly matter more if we’re in a low return environment,” says Tim Barron chief investment officer of Segal Rogerscasey in Darien, Connecticut. Barron explains to PLANSPONSOR that there is a behavioral bias that says managers charging higher fees are better at managing, but over the past decade, this has not been the case. “Retirement plan sponsors must assess everything, and not let behavioral bias cause bad decisions.”
Performance and price are relevant, but plan sponsors must also consider an asset manager’s process, people and philosophy, he adds.
However, according to Barron, the analysis shows if price or cost is the only information a plan sponsor has, then they are better off choosing lower-fee options for better returns. “We’re not suggesting passive investing is the best solution, but if the only information you have is fees, go with low-cost,” he says.
“Active managers can add value, and price should be considered, but within the context of all information,” he adds.
As for the investment choices retirement plan participants make, Barron says there has to be education about how all things interact for fund performance. Plan sponsors should include participant education regarding their investment choices, the impact of fees, as well as risk versus return potential.
The Segal Rogerscasey Investment Insight is here.
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